Category Archives: Michael Hudson

Wall Street’s War Against the Cities: Why Bondholders Can’t – and Shouldn’t – be Paid

By Michael Hudson

The Bubble and BeyondThe pace of Wall Street’s war against the 99% is quickening in preparation for the kill. Having demonized public employees for being scheduled to receive pensions on their lifetime employment service, bondholders are insisting on getting the money instead. It is the same austerity philosophy that has been forced on Greece and Spain – and the same that is prompting President Obama and Mitt Romney to urge scaling back Social Security and Medicare.

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Why Latvia’s Austerity Model Can’t Be Exported

By Michael Hudson and Jeffrey Sommers
(Cross-posted from FT)

Austerity’s advocates depict Latvia as a plucky country that can show Europe the way out of its financial dilemma – by “internal devaluation”, or slashing wages. Yet few of the enthusiastic commentators have spent enough time in Latvia to understand what happened. Its government has chosen austerity, its people have not. Finding no acceptable alternative, much of the labour force has elected to emigrate. This is a major factor holding down its unemployment rate to “just” 15 per cent today. Continue reading

Productivity, The Miracle of Compound Interest, and Poverty

By Michael Hudson
This is a re-working of my second talk at the Rimini MMT conference, as heard on Guns and Butter.

Suppose you were alive back in 1945 and were told about all the new technology that would be invented between then and now: the computers and internet, mobile phones and other consumer electronics, faster and cheaper air travel, super trains and even outer space exploration, higher gas mileage on the ground, plastics, medical breakthroughs and science in general. You would have imagined what nearly all futurists expected: that we would be living in a life of leisure society by this time. Rising productivity would raise wages and living standards, enabling people to work shorter hours under more relaxed and less pressured workplace conditions.

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2,181 Italians Pack a Sports Arena to Learn Modern Monetary Theory: The Economy Doesn’t Need to Suffer Neoliberal Austerity

By Michael Hudson

I have just returned from Rimini, Italy, where I experienced one of the most amazing spectacles of my academic life. Four of us associated with the University of Missouri at Kansas City (UMKC) were invited to lecture for three days on Modern Monetary Theory (MMT) and explain why Europe is in such monetary trouble today – and to show that there is an alternative, that the enforced austerity for the 99% and vast wealth grab by the 1% is not a force of nature.

Stephanie Kelton (incoming UMKC Economics Dept. chair and editor of its economic blog, New Economic Perspectives), criminologist and law professor Bill Black, investment banker Marshall Auerback and me (along with a French economist, Alain Parquez) stepped into the basketball auditorium on Friday night. We walked down, and down, and further down the central aisle, past a packed audience reported as over 2,100. It was like entering the Oscars as People called out our first names. Some told us they had read all of our economics blogs. Stephanie joked that now she understood how the Beatles felt. There was prolonged applause – all for an intellectual rather than a physical sporting event.

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Thousands Turn Out to Learn MMT in Italy

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?

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
[2], 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),

Geithner’s Ploy: Saving U.S. Banks at Taxpayer Expense, Once Again

By Michael Hudson

U.S. and foreign stockmarkets continue to zigzag wildly in response to expectations about whether theeuro can survive, in the face of populations suffering under neoliberalausterity policies being imposed on Ireland, Greece, Spain, Italy, etc. Here’sthe story that I’m being told by Europeans regarding the recent turmoil inGreece and other European debtor and budget-deficit economies. (The details arenot out, as the negotiations have been handled in utter secrecy. So whatfollows is a reconstruction.)

In autumn 2012, it became apparentthat Greece could not roll over its public debt. The EU concluded that debtshad to be written down by 50 percent. The alternative was outright default onall debt. So basically, the solution for Greece reflected what had happened toLatin American debt in the 1980s, when governments replaced existing debts andbank loans with Brady bonds, named for Reagan Treasury Secretary Nicolas F.Brady. These bonds had a lower principal, but at least their payment was deemedsecure. And indeed, their payments were made.

This write-down seemed radical, butEuropean banks already had hedged their bets and taken out default insurance.U.S. banks were the counterparties to much of this insurance.

In December (?) 2011, a quartercentury after Mr. Brady, Mr. Obama’s Secretary Geithner went to Europe met withEU leaders to demand that Greece make the write-downs voluntary on the part ofbanks and creditors. He explained that U.S. banks had bet that Greece would notdefault – and their net worth position was so shaky that if they had to pay ontheir bad gambles, they would go broke.
As German bankers have described thesituation to me, Mr. Geithner said he would kill the European banks andeconomies if they did not agree to take it on the chin and suffer the lossesthemselves – so that U.S. banks would not have to pay off on the collateralizeddefault swaps (CDOs) and other gambles for which they had collected billions ofdollars.

Europeans were enraged. But Mr.Geithner made a deal. OK, he finally agreed: The White House would indeedpermit Greece to default. But America needed time.

He agreed to open a credit line fromthe Federal Reserve Bank to the European Central Bank (ECB). The Fed wouldprovide the money to lend to banks during the interim when European governmentfinances faltered. The banks would be given time to unwind their defaultguarantees. In the end, the ECB would be the creditor. It – and presumably theFed – would bear the losses, “at taxpayer expense.” The U.S. banks (andprobably the European ones too) can avoid taking a loss that would wipe outtheir net worth.

What really are the details? What wedo know is that U.S. banks are pulling bank their credit lines to Europeanbanks and other borrowers as the old ones expire. The ECB is stepping in tofill the gap. This is called ‘providing liquidity,’ but it seems more to be acase of providing solvency for a basically insolvent situation. A debt thatcan’t be paid, won’t be, after all.

Geithner’s idea is that what workedbefore will work again. When the Federal Reserve or Treasury picks up a bankloss, they simply print government debt or open a Federal Reserve bank depositfor the banks. The public doesn’t view this as being as blatant as simplyhanding out money. The government says it is “saving the financial system,”without spelling out the cost at “taxpayer expense” (not that of the banks!).

It’s a giveaway.

Europe’s Transition From Social Democracy to Oligarchy

By Michael Hudson
This article was first published by Frankfurter Allgemeine Zeitung, Dec. 3, 2011, as “Der Krieg der Banken gegen das Volk.

The easiest way to understandEurope’s financial crisis is to look at the solutions being proposed to resolveit. They are a banker’s dream, a grab bag of giveaways that few voters would belikely to approve in a democratic referendum. Bank strategists learned not torisk submitting their plans to democratic vote after Icelanders twice refusedin 2010-11 to approve their government’s capitulation to pay Britain and theNetherlands for losses run up by badly regulated Icelandic banks operatingabroad. Lacking such a referendum, mass demonstrations were the only way forGreek voters to register their opposition to the €50 billion in privatizationsell-offs demanded by the European Central Bank (ECB) in autumn 2011.
The problemis that Greece lacks the ready money to redeem its debts and pay the interestcharges. The ECB is demanding that it sell off public assets – land, water andsewer systems, ports and other assets in the public domain, and also cut backpensions and other payments to its population. The “bottom 99%” understandablyare angry to be informed that the wealthiest layer of the population  is largely responsible for the budgetshortfall by stashing away a reported €45 billion of funds stashed away inSwiss banks alone. The idea of normal wage-earners being obliged to forfeittheir pensions to pay for tax evaders – and for the general un-taxing of wealthsince the regime of the colonels – makes most people understandably angry. Forthe ECB, EU and IMF “troika” to say that whatever the wealthy take, steal orevade paying must be made up by the population at large is not a politicallyneutral position. It comes down hard on the side of wealth that has beenunfairly taken.
A democratictax policy would reinstate progressive taxation on income and property, andwould enforce its collection – with penalties for evasion. Ever since the 19thcentury, democratic reformers have sought to free economies from waste,corruption and “unearned income.” But the ECB “troika” is imposing a regressivetax – one that can be imposed only by turning government policy-making over toa set of unelected “technocrats.”
Tocall the administrators of so anti-democratic a policy “technocrats” seems tobe a cynical scientific-sounding euphemism for financial lobbyists orbureaucrats deemed suitably tunnel-visioned to act as useful idiots on behalfof their sponsors. Theirideology is the same austerity philosophy that the IMF imposed on Third Worlddebtors from the 1960s through the 1980s. Claiming to stabilize the balance ofpayments while introducing free markets, these officials sold off exportsectors and basic infrastructure to creditor-nation buyers. The effect was todrive austerity-ridden economies even deeper into debt – to foreign bankers andtheir own domestic oligarchies.
Thisis the treadmill on which Eurozone social democracies are now being placed.Under the political umbrella of financial emergency, wages and living standardsare to be scaled back and political power shifted from elected government totechnocrats governing on behalf of large banks and financial institutions.Public-sector labor is to be privatized – and de-unionized, while SocialSecurity, pension plans and health insurance are scaled back.
Thisis the basic playbook that corporate raiders follow when they empty outcorporate pension plans to pay their financial backers in leveraged buyouts. Italso is how the former Soviet Union’s economy was privatized after 1991, transferringpublic assets into the hands of kleptocrats, who worked with Western investmentbankers to make the Russian and other stock exchanges the darlings of theglobal financial markets. Property taxes were scaled back while flat taxes wereimposed on wages (a cumulative 59 percent in Latvia). Industry was dismantledas land and mineral rights were transferred to foreigners, economies driveninto debt and skilled and unskilled labor alike was obliged to emigrate to findwork.
Pretendingto be committed to price stability and free markets, bankers inflated a realestate bubble on credit. Rental income was capitalized into bank loans and paidout as interest. This was enormously profitable for bankers, but it left theBaltics and much of Central Europe debt strapped and in negative equity by2008. Neoliberals applaud their plunging wage levels and shrinking GDP as asuccess story, because these countries shifted the tax burden onto employmentrather than property or finance. Governments bailed out banks at taxpayerexpense.
Itis axiomatic that the solution to any major social problem tends to create evenlarger problems – not always unintended! From the financial sector’s vantagepoint, the “solution” to the Eurozone crisis is to reverse the aims of theProgressive Era a century ago – what John Maynard Keynes gently termed“euthanasia of the rentier” in 1936.The idea was to subordinate the banking system to serve the economy rather thanthe other way around. Instead, finance has become the new mode of warfare –less ostensibly bloody, but with the same objectives as the Viking invasionsover a thousand years ago, and Europe’s subsequent colonial conquests:appropriation of land and natural resources, infrastructure and whatever otherassets can provide a revenue stream. It was to capitalize and estimate suchvalues, for instance, that William the Conqueror compiled the Domesday Bookafter 1066, a model of ECB and IMF-style calculations today.
Thisappropriation of the economic surplus to pay bankers is turning the traditionalvalues of most Europeans upside down. Imposition of economic austerity,dismantling social spending, sell-offs of public assets, de-unionization oflabor, falling wage levels, scaled-back pension plans and health care incountries subject to democratic rules requires convincing voters that there isno alternative. It is claimed that without a profitable banking sector (nomatter how predatory) the economy will break down as bank losses on bad loansand gambles pull down the payments system. No regulatory agencies can help, nobetter tax policy, nothing except to turn over control to lobbyists to savebanks from losing the financial claims they have built up.
What banks wantis for the economic surplus to be paid out as interest, not used for risingliving standards, public social spending or even for new capital investment.Research and development takes too long. Finance lives in the short run. Thisshort-termism is self-defeating, yet it is presented as science. Thealternative, voters are told, is the road to serfdom: interfering with the“free market” by financial regulation and even progressive taxation.
Thereis an alternative, of course. It is what European civilization from the 13th-centurySchoolmen through the Enlightenment and the flowering of classical politicaleconomy sought to create: an economy free of unearned income, free of vestedinterests using special privileges for “rent extraction.” At the hands of theneoliberals, by contrast, a free market is one free for a tax-favored rentierclass to extract interest, economic rent and monopoly prices.
Rentier interests present their behavioras efficient “wealth creation.” Business schools teach privatizers how toarrange bank loans and bond financing by pledging whatever they can charge forthe public infrastructure services being sold by governments. The idea is topay this revenue to banks and bondholders as interest, and then make a capitalgain by raising access fees for roads and ports, water and sewer usage andother basic services. Governments are told that economies can be run moreefficiently by dismantling public programs and selling off assets.
Neverhas the gap between pretended aim and actual effect been more hypocritical.Making interest payments (and even capital gains) tax-exempt deprives governmentsof revenue from the user fees they are relinquishing, increasing their budgetdeficits. And instead of promoting price stability (the ECB’s ostensiblepriority), privatization increases prices for infrastructure, housing and othercosts of living and doing business by building in interest charges and otherfinancial overhead – and much higher salaries for management. So it is merely aknee-jerk ideological claim that this policy is more efficient simply becauseprivatizers do the borrowing rather than government.
Thereis no technological or economic need for Europe’s financial managers to imposedepression on much of its population. But there is a great opportunity to gainfor the banks that have gained control of ECB economic policy. Since the 1960s,balance-of-payments crises have provided opportunities for bankers and liquidinvestors to seize control of fiscal policy – to shift the tax burden ontolabor and dismantle social spending in favor of subsidizing foreign investorsand the financial sector. They gain from austerity policies that lower livingstandards and scale back social spending. A debt crisis enables the domesticfinancial elite and foreign bankers to indebt the rest of society, using theirprivilege of credit (or savings built up as a result of less progressive taxpolicies) as a lever to grab assets and reduce populations to a state of debtdependency.
Thekind of warfare now engulfing Europe is thus more than just economic in scope.It threatens to become a historic dividing line between the past half-century’sepoch of hope and technological potential to a new era of polarization as afinancial oligarchy replaces democratic governments and reduces populations todebt peonage.
For so boldan asset and power grab to succeed, it needs a crisis to suspend the normalpolitical and democratic legislative processes that would oppose it. Politicalpanic and anarchy create a vacuum into which grabbers can move quickly, usingthe rhetoric of financial deception and a junk economics to rationalizeself-serving solutions by a false view of economic history – and in the case oftoday’s ECB, German history in particular.
A central bank that is blocked from acing like one
Governmentsdo not need to borrow from commercial bankers or other lenders. Ever since theBank of England was founded in 1694, central banks have printed money tofinance public spending. Bankers also create credit feely – when they make aloan and credit the customer’s account, in exchange for a promissory notebearing interest. Today, these banks can borrow reserves from the governmentcentral bank at a low annual interest rate (0.25% in the United States) andlend it out at a higher rate. So banks are glad to see the government’s centralbank create credit to lend to them. But when it comes to governments creatingmoney to finance their budget deficits for spending in the rest of the economy,banks would prefer to have this market and its interest return for themselves.
Europeancommercial banks are especially adamant that the European Central Bank shouldnot finance government budget deficits. But private credit creation is notnecessarily less inflationary than governments monetizing their deficits(simply by printing the money needed). Most commercial bank loans are madeagainst real estate, stocks and bonds – providing credit that is used to bid uphousing prices, and prices for financial securities (as in loans for leveragedbuyouts).
Itis mainly government that spends credit on the “real” economy, to the extentthat public budget deficits employ labor or are spent on goods and services. Ifgovernments avoid paying interest by having their central banks printing moneyon their own computer keyboards rather than borrowing from banks that do thesame thing on their own keyboards. (Abraham Lincoln simply printed currencywhen he financed the U.S. Civil War with “greenbacks.”)
Bankswould like to use their credit-creating privilege to obtain interest forlending to governments to finance public budget deficits. So they have aself-interest in limiting the government’s “public option” to monetize itsbudget deficits. To secure a monopoly on their credit-creating privilege, bankshave mounted a vast character assassination on government spending, and indeedon government authority in general – which happens to be the only authoritywith sufficient power to control their power or provide an alternative publicfinancial option, as Post Office savings banks do in Japan, Russia and othercountries. This competition between banks and government explains the falseaccusations made that government credit creation is more inflationary than whencommercial banks do it.
Thereality is made clear by comparing the ways in which the United States, Britainand Europe handle their public financing. The U.S. Treasury is by far theworld’s largest debtor, and its largest banks seem to be in negative equity,liable to their depositors and to other financial institutions for much largersums that can be paid by their portfolio of loans, investments and assortedfinancial gambles. Yet as global financial turmoil escalates, institutionalinvestors are putting their money into U.S. Treasury bonds – so much that thesebonds now yield less than 1%. By contrast, a quarter of U.S. real estate is innegative equity, American states and cities are facing insolvency and mustscale back spending. Large companies are going bankrupt, pension plans arefalling deeper into arrears, yet the U.S. economy remains a magnet for globalsavings.
Britain’seconomy also is staggering, yet its government is paying just 2% interest. ButEuropean governments are now paying over 7%. The reason for this disparity isthat they lack a “public option” in money creation. Having a Federal Reserve Bankor Bank of England that can print the money to pay interest or roll overexisting debts is what makes the United States and Britain different fromEurope. Nobody expects these two nations to be forced to sell off their publiclands and other assets to raise the money to pay (although they may do this asa policy choice). Given that the U.S. Treasury and Federal Reserve can createnew money, it follows that as long as government debts are denominated indollars, they can print enough IOUs on their computer keyboards so that theonly risk that holders of Treasury bonds bear is the dollar’s exchange ratevis-à-vis other currencies.
Bycontrast, the Eurozone has a central bank, but Article 123 of the Lisbon treatyforbids the ECB from doing what central banks were created to do: create themoney to finance government budget deficits or roll over their debt fallingdue. Future historians no doubt will find it remarkable that there actually isa rationale behind this policy – or at least the pretense of a cover story. Itis so flimsy that any student of history can see how distorted it is. The claimis that if a central bank creates credit, this threatens price stability. Onlygovernment spending is deemed to be inflationary, not private credit!
TheClinton Administration balanced the U.S. Government budget in the late 1990s,yet the Bubble Economy was exploding. On the other hand, the Federal Reserveand Treasury flooded the economy with $13 trillion in credit to the bankingsystem credit after September 2008, and $800 billion more last summer in theFederal Reserve’s Quantitative Easing program (QE2). Yet consumer and commodityprices are not rising. Not even real estate or stock market prices are beingbid up. So the idea that more money will bid up prices (MV=PT) is not operatingtoday.
Commercialbanks create debt. That is their product. This debt leveraging was used formore than a decade to bid up prices – making housing and buying a retirementincome more expensive for Americans – but today’s economy is suffering fromdebt deflation as personal income, business and tax revenue is diverted to paydebt service rather than to spend on goods or invest or hire labor.
Muchmore striking is the travesty of German history that is being repeated againand again, as if repetition somehow will stop people from remembering whatactually happened in the 20th century. To hear ECB officials tellthe story, it would be reckless for a central bank to lend to government,because of the danger of hyperinflation. Memories are conjured up of the Weimarinflation in Germany in the 1920s. But upon examination, this turns out to bewhat psychiatrists call an implanted memory – a condition in which a patient isconvinced that they have suffered a trauma that seems real, but which did notexist in reality.
Whathappened back in 1921 was not a case of governments borrowing from centralbanks to finance domestic spending such as social programs, pensions or healthcare as today. Rather, Germany’s obligation to pay reparations led theReichsbank to flood the foreign exchange markets with deutsche marks to obtainthe currency to buy pounds sterling, French francs and other currency to paythe Allies – which used the money to pay their Inter-Ally arms debts to theUnited States. The nation’s hyperinflation stemmed from its obligation to payreparations in foreign currency. No amount of domestic taxation could haveraised the foreign exchange that was scheduled to be paid.
Bythe 1930s this was a well-understood phenomenon, explained by Keynes and otherswho analyzed the structural limits on the ability to pay foreign debt imposed without regard for the ability to pay out ofcurrent domestic-currency budgets. From Salomon Flink’s The Reichsbank and Economic Germany (1931) to studies of theChilean and other Third World hyperinflations, economists have found a commoncausality at work, based on the balance of payments. First comes a fall in theexchange rate. This raises the price of imports, and hence the domestic pricelevel. More money is then needed to transact purchases at the higher pricelevel. The statistical sequence and lineof causation leads from balance-of-payments deficits to currency depreciationraising import costs, and from these price increases to the money supply, not the other way around.
Today’s“free marketers” writing in the Chicago monetarist tradition (basically that ofDavid Ricardo) leaves the foreign and domestic debt dimensions out of account.It is as if “money” and “credit” are assets to be bartered against goods. But abank account or other form of credit means debt on the opposite side of thebalance sheet. One party’s debt is another party’s saving – and most savingstoday are lent out at interest, absorbing money from the non-financial sectors of the economy. The discussion isstripped down to a simplistic relationship between the money supply and pricelevel – and indeed, only consumer prices, not asset prices. In their eagernessto oppose government spending – and indeed to dismantle government and replaceit with financial planners – neoliberal monetarists neglect the debt burdenbeing imposed today from Latvia and Iceland to Ireland and Greece, Italy, Spainand Portugal.
Ifthe euro breaks up, it is because of the obligation of governments to pay bankersin money that must be borrowed rather than created through their own centralbank. Unlike the United States and Britain which can create central bank crediton their own computer keyboards to keep their economy from shrinking orbecoming insolvent, the German constitution and the Lisbon Treaty prevent thecentral bank from doing this.
Theeffect is to oblige governments to borrow from commercial banks at interest.This gives bankers the ability to create a crisis – threatening to driveeconomies out of the Eurozone if they do not submit to “conditionalities” beingimposed in what quickly is becoming a new class war of finance against labor.
Disabling Europe’s central bank to deprive governments of the power tocreate money
Oneof the three defining characteristics of a nation-state is the power to createmoney. A second characteristic is the power to levy taxes. Both of these powersare being transferred out of the hands of democratically electedrepresentatives to the financial sector, as a result of tying the hands ofgovernment.
Thethird characteristic of a nation-state is the power to declare war. What ishappening today is the equivalent of warfare – but against the power of government! It is above all a financial modeof warfare – and the aims of this financial appropriation are the same as thoseof military conquest: first, the land and subsoil riches on which to chargerents as tribute; second, public infrastructure to extract rent as access fees;and third, any other enterprises or assets in the public domain.
Inthis new financialized warfare, governments are being directed to act asenforcement agents on behalf of the financial conquerors against their owndomestic populations. This is not new, to be sure. We have seen the IMF andWorld Bank impose austerity on Latin American dictatorships, African militarychiefdoms and other client oligarchies from the 1960s through the 1980s.Ireland and Greece, Spain and Portugal are now to be subjected to similar assetstripping as public policy making is shifted into the hands ofsupra-governmental financial agencies acting on behalf of bankers – and therebyfor the top 1% of the population.
Whendebts cannot be paid or rolled over, foreclosure time arrives. For governments,this means privatization selloffs to pay creditors. In addition to being aproperty grab, privatization aims at replacing public sector labor with anon-union work force having fewer pension rights, health care or voice inworking conditions. The old class war is thus back in business – with afinancial twist. By shrinking the economy, debt deflation helps break the powerof labor to resist.
Italso gives creditors control of fiscal policy. In the absence of a pan-EuropeanParliament empowered to set tax rules, fiscal policy passes to the ECB. Acting onbehalf of banks, the ECB seems to favor reversing the 20th century’sdrive for progressive taxation. And as U.S. financial lobbyists have madeclear, the creditor demand is for governments to re-classify public socialobligations as “user fees,” to be financed by wage withholding turned over tobanks to manage (or mismanage, as the case may be). Shifting the tax burden offreal estate and finance onto labor and the “real” economy thus threatens tobecome a fiscal grab coming on top of the privatization grab.
Thisis self-destructive short-termism. The irony is that the PIIGS budget deficitsstem largely from un-taxing property, and a further tax shift will worsenrather than help stabilize government budgets. But bankers are looking only atwhat they can take in the short run. They know that whatever revenue the taxcollector relinquishes from real estate and business is “free” for buyers topledge to the banks as interest. So Greece and other oligarchic economies aretold to “pay their way” by slashing government social spending (but notmilitary spending for the purchase of German and French arms) and shiftingtaxes onto labor and industry, and onto consumers in the form of higher userfees for public services not yet privatized.
In Britain,Prime Minister Cameron claims that scaling back government even more alongThatcherite-Blairite lines will leave more labor and resources available forprivate business to hire. Fiscal cutbacks will indeed throw labor out of work,or at least oblige it to find lower-paid jobs with fewer rights. But cuttingback public spending will shrink the business sector as well, worsening thefiscal and debt problems by pushing economies deeper into recession.
Ifgovernments cut back their spending to reduce the size of their budget deficits– or if they raise taxes on the economy at large, to run a surplus – then thesesurpluses will suck money out of the economy, leaving less to be spent on goodsand services. The result can only be unemployment, further debt defaults andbankruptcies. We may look to Iceland and Latvia as canaries in this financialcoalmine. Their recent experience shows that debt deflation leads toemigration, shortening life spans, lower birth rates, marriages and familyformation – but provides great opportunities for vulture funds to suck wealthupward to the top of the financial pyramid.
Today’seconomic crisis is a matter of policy choice, not necessity. As PresidentObama’s chief of staff Rahm Emanuel quipped: “A crisis is too good anopportunity to let go to waste.” In such cases the most logical explanation isthat some special interest must be benefiting. Depressions increaseunemployment, helping to break the power of unionized as well as non-unionlabor. The United States is seeing a state and local budget squeeze (asbankruptcies begin to be announced), with the first cutbacks coming in thesphere of pension defaults. High finance is being paid – by not paying theworking population for savings and promises made as part of labor contracts andemployee retirement plans. Big fish are eating little fish.
Thisseems to be the financial sector’s idea of good economic planning. But it isworse than a zero-sum plan, in which one party’s gain is another’s loss.Economies as a whole will shrink – and change their shape, polarizing betweencreditors and debtors. Economic democracy will give way to financial oligarchy,reversing the trend of the past few centuries.
IsEurope really ready to take this step? Do its voters recognize that strippingthe government of the public option of money creation will hand the privilegeover to banks as a monopoly? How many observers have traced the almostinevitable result: shifting economic planning and credit allocation to thebanks?
Even ifgovernments provide a “public option,” creating their own money to financetheir budget deficits and supplying the economy with productive credit torebuild infrastructure, a serious problem remains: how to dispose of theexisting debt overhead now acts as a deadweight on the economy. Bankers and thepoliticians they back are refusing to write down debts to reflect the abilityto pay. Lawmakers have not prepared society with a legal procedure for debtwrite-downs – except for New York State’s Fraudulent Conveyance Law, callingfor debts to be annulled if lenders made loans without first assuringthemselves of the debtor’s ability to pay.
Bankers donot want to take responsibility for bad loans. This poses the financial problemof just what policy-makers should do when banks have been so irresponsible inallocating credit. But somebody has to take a loss. Should it be society atlarge, or the bankers?
It is not aproblem that bankers are prepared to solve. They want to turn the problem overto governments – and define the problem as how governments can “make themwhole.” What they call a “solution” to the bad-debt problem is for thegovernment to give them good bonds for bad loans (“cash for trash”) – to bepaid in full by taxpayers. Having engineered an enormous increase in wealth forthemselves, bankers now want to take the money and run – leaving economies debtridden. The revenue that debtors cannot pay will now be spread over the entireeconomy to pay – vastly increasing everyone’s cost of living and doing business.
Whyshould they be “made whole,” at the cost of shrinking the rest of the economy? Thebankers’ answer is that debts are owed to labor’s pension funds, to consumerswith bank deposits, and the whole system will come crashing down if governmentsmiss a bond payment. When pressed, bankers admit that they have taken out riskinsurance – collateralized debt obligations and other risk swaps. But theinsurers are largely U.S. banks, and the American Government is pressuringEurope not to default and thereby hurt the U.S. banking system. So the debttangle has become politicized internationally.
Sofor bankers, the line of least resistance is to foster an illusion that thereis no need for them to accept defaults on the unpayably high debts they haveencouraged.  Creditors always insist thatthe debt overhead can be maintained – if governments simply will reduce otherexpenditures, while raising taxes on individuals and non-financial business.
The reason whythis won’t work is that trying to collect today’s magnitude of debt will injurethe underlying “real” economy, making it even less able to pay its debts. Whatstarted as a financial problem (bad debts) will now be turned into a fiscalproblem (bad taxes). Taxes are a cost of doing business just as paying debtservice is a cost. Both costs must be reflected in product prices. Whentaxpayers are saddled with taxes and debts, they have less revenue free tospend on consumption. So markets shrink, putting further pressure on theprofitability of domestic enterprises. The combination makes any countryfollowing such policy a high-cost producer and hence less competitive in globalmarkets.
Thiskind of financial planning – and its parallel fiscal tax shift – leads towardde-industrialization. Creating ECB or IMF inter-government fiat money leavesthe debts in place, while preserving wealth and economic control in the handsof the financial sector. Banks can receive debt payments on overly mortgagedproperties only if debtors are relieved of some real estate taxes. Debt-strappedindustrial companies can pay their debts only by scaling back pensionobligations, health care and wages to their employees – or tax payments to thegovernment. In practice, “honoring debts” turns out to mean debt deflation and general economic shrinkage.
Thisis the financiers’ business plan. But to leave tax policy and centralizedplanning in the hands of bankers turns out to be the opposite of what the pastfew centuries of free market economics have been all about. The classicalobjective was to minimize the debt overhead, to tax land and natural resourcerents, and to keep monopoly prices in line with actual costs of production(“value”). Bankers have lent increasingly against the same revenues that freemarket economists believed should be the natural tax base.
Sosomething has to give. Will it be the past few centuries of liberal free-marketeconomic philosophy, relinquishing planning the economic surplus to bankers? Orwill society re-assert classical economic philosophy and Progressive Eraprinciples, and re-assert social shaping of financial markets to promotelong-term growth with minimum costs of living and doing business?


At least in the most badly indebtedcountries, European voters are waking up to an oligarchic coup in which taxationand government budgetary planning and control is passing into the hands ofexecutives nominated by the international bankers’ cartel. This result is theopposite of what the past few centuries of free market economics has been allabout.

“No People, No Problem”: The Baltic Tigers’ False Prophets of Austerity

By Jeffrey Sommers, Arunas Juska and Michael Hudson*
(Cross-posted from Counterpunch)
The Baltic states have discovered a new way to cut unemployment and cut budgets for social services: emigration. If enough people of working age are forced to leave to find work abroad, unemployment and social service budgets will both drop.
This simple mathematics explains what the algebra of austerity-plan advocates are applauding today as the “New Baltic Miracle” for Greece, Spain, and Italy to emulate. The reality, however, is a model predicated on economic shrinkage as a result of wage cuts. In the case of Latvia, this was some 30 percent for Latvian public-sector employees (euphemized as “internal devaluation”). With a set of flat taxes on employment adding up to 59% in Latvia (while property taxes are only 1%), it would seem hard indeed to present this as a success story.