Michael Hudson

 

Recent Posts by Michael Hudson

  • Adam Smith Would Have Shredded the Bowles-Simpson Tax Madness

    Dec 8, 2010Michael Hudson

    adam-smithReal free marketers should be calling for an economy that favors workers, not rent seekers and creditors.

    What would Adam Smith have said about the Bowles-Simpson economic report?

    adam-smithReal free marketers should be calling for an economy that favors workers, not rent seekers and creditors.

    What would Adam Smith have said about the Bowles-Simpson economic report?

    What a pity the great free marketer was not around to serve on the deficit reduction commission. He not only would have rolled over in his grave, he would have risen up wielding an ax to the fiscal proposals that are diametrically opposite to the fiscal principles that he and his original free market contemporaries urged.

    Writing in the wake of the French Physiocrats with their Impôt Unique to collect the revenues that France's landed aristocracy drained from the countryside and towns, Smith endorsed the idea that the least burdensome tax was one that fell on land rent:

    A more equal land-tax, a more equal tax upon the rent of houses, and such alterations in the present system of customs and excise as those which have been mentioned in the foregoing chapter might, perhaps, without increasing the burden of the greater part of the people, but only distributing the weight of it more equally upon the whole, produce a considerable augmentation of revenue. (Wealth of Nations, Book V.3.68)

    If Britain were to become a dominant economic power, Smith argued, its industrial capitalism would have to shed the vestiges of feudalism. Ground rent charged by its landed aristocracy should be taxed away on the logic that it was the prototypical "free lunch" revenue with no counterpart cost of production. He noted at the outset (Book I, ch. xi) that there were "some parts of the produce of land for which the demand must always be such as to afford a greater price than what is sufficient to bring them to market." In 1814, David Buchanan published an edition of The Wealth of Nations with a volume of his own notes and commentary, attributing rent to monopoly (III:272n), and concluding that it represented a mere transfer payment, not actually reimbursing the production of value. High rents enriched landlords at the expense of food consumers -- what economists call a zero-sum game at another's expense.

    The 19th century elaborated on the concept of economic rent as that element of price which found no counterpart in actual cost of production and hence was "unearned." It was a form of economic overhead that added unnecessarily to prices. In 1817, David Ricardo's Principles of Political Economy and Taxation elaborated on the concept of economic rent. Under conditions of diminishing soil fertility in the face of growing demand, value was set at the high-cost margin of production. Low-cost producers benefited from the rising price level. Ricardo helped clarify the concept of differential rent by applying it to mining and subsoil wealth as well as to land. Heinrich von Thünen soon added the more helpful concept of rent-of-location (site value).

    The important classical point was that economic rent was produced either by nature or by special privilege ("monopoly"), not labor effort. Hence, it was that element of price that could not be explained by the labor theory of value, except by marginal costs on what Ricardo hypothesized to be "rentless land" as recourse was made to poorer soils. Ricardo's follower John Stuart Mill explained that being income without labor or other costs, such rent formed the natural basis for taxation.

    The Progressive Era developed the view that public utilities and other natural monopolies rightly belonged in the public sector, where governments would provide their basic services at a subsidized price, or even freely, as in the case of roads. The idea was to keep user fees no higher than the actual cost of production, so as to avoid "rent seeking". This pejorative term means extracting income by placing tollbooths on the economy's key infrastructure. To leave roads and railroads, electric and power utilities in private hands ran the risk of private owners "rack-renting" the population, adding to the cost of living and doing business.

    U.S. policy is just the opposite. Commercial real estate has been regressively "freed" from debt -- leaving the rental value to be pledged to banks as interest. This un-taxing of land rent has been a major factor in inflating the real estate bubble on credit, much as deregulating monopolies has helped inflate their stocks and bonds on credit.

    This is the policy that the Bowles-Simpson deficit reduction commission endorses. Its regressive tax proposals would shrink the economy, pushing it further into debt. This transfer of revenue from labor and business to property owners -- and from them to their bankers and bondholders -- threatens to force up the government's fiscal deficit (as states and municipalities are seeing today) and turn the United States into a Third World-type neofeudal economy.

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    Smith: Wars should be financed on a pay-as-you-go basis, not by borrowing

    If the shade of Adam Smith were to reappear today, he would be equally disturbed by the failure of the Bowles-Simpson commission to address the issue of war debts. Smith's argument against waging foreign wars was basically an argument that they were not worth the debt burden and the associated taxes to pay interest on it. These payments transferred income from taxpayers to creditors -- largely foreign creditors, the Dutch in Smith's day, Asians today.

    Neither Bowles-Simpson nor President Obama acknowledge the extent to which the federal debt -- and indeed, most of America's rise in foreign debt for decades on end -- has stemmed from overseas military spending. During the Vietnam War years of the 1960s and ‘70s, the military deficit accounted for the entire rise in U.S. foreign debt, as private sector trade and investment was exactly in balance.

    Smith wrote that even a land tax could not finance governments or "compensate the further accumulation of the public debt in the next war." His argument was that to free the economy from taxes, nations should avoid wars. And the best way to do this was to wage them on a pay-as-you-go basis. Borrowing rather than taxing meant the population did not feel the real cost of war -- and thus deterred it from making an economically informed choice.

    So the Bush-Obama administration has taken a fiscal stance diametrically opposed to that of the patron saint of free enterprise. While escalating war in Afghanistan and maintaining over 850 military bases around the world, the administration has run up the national debt that Smith decried. By shifting the tax burden off property and off rent-seeking monopolies -- above all, off the financial sector -- this policy has raised America's cost of living and doing business, thereby undercutting its competitive power and running up larger and larger foreign debt.

    The Wealth of Nations traced the growth of Britain's national debt, listing how all new war borrowing was secured by a new excise tax. Writing in the wake of the Seven Years War with France, fought largely over their respective possessions in the New World, Smith urged Britain to free its American colonies. In a similar vein, after France's Revolution, its Minister of the Navy, Bertrand de Molleville, wrote that Louis XVI in 1792 had blamed the overthrow of his monarchy on the burdensome taxes levied to finance the war with Britain in America.

    This did not prevent a new wave of Franco-British war under Napoleon, and by the time this new wave of warfare ended in 1815, interest charges absorbed some three-quarters of British government revenues and devastated French finances. Led by Henri de Saint-Simon, French free marketers focused as much on freeing economies from interest-bearing debt as the Physiocrats had sought to tax the landed nobility.

    The balance of the 19th century saw a move throughout Europe to endorse progressive taxation. The aim was not class warfare that takes from the rich to give to the poor. Led by the industrial middle class and its leaders, the aim was to make national economies more competitive by freeing them from economic rent and private bank credit. Landlords and bankers were the two rentier classes bequeathed by Europe's feudal epoch: a hereditary aristocracy receiving land rent simply by virtue of birth and ownership, and banking based increasingly on securing the monopoly of credit creation as a means of extracting interest. Pressure grew to socialize the land's rental value and financial systems so that the economic surplus created by monopoly privilege and the rise in national prosperity would form the natural tax base, not excise taxes on consumer goods and incomes that increased the cost of living (and hence the break-even costs of labor) and of capital.

    None of this classical free market theory is to be found in the Bowles-Simpson commission. It advocates a continued shift of the tax burden off property and the wealthiest layer of the population onto labor, as well as a fiscal giveaway to the vested interests. This is not what the classical economists meant by a free market. Their idea was to free markets from rent and interest, not to dismantle the government's power to tax and regulate prices to keep them in line with socially necessary costs of production.

    So where are the "real" conservatives and free marketers today? They have been dropped from the academic curriculum. This virtual censorship is what enables the media to avoid calling the Bowles-Simpson commission what it is: a travesty of free market theory.

    The way that Adam Smith would have addressed the deficit would have been to say, "Mr. Obama, pull out of Afghanistan -- and perhaps 850 of our foreign bases." And the century of free market economists who followed Smith would have said, "Tax away unearned rentier income. And do not pay creditors by selling off the private domain to rent-seeking privatizers erecting tollbooths on the economy." That was precisely the legacy of feudalism that free market theory was designed to reject, after all.

    In view of the conspicuous absence of true free market conservatives, it is clear that President Obama selected members of the Bowles-Simpson commission to provide a rationale -- or at least a rhetorical cover story -- for turning the U.S. economy into a neofeudal one. It will be increasingly indebted to creditors, enjoying their revenue and "capital" gains (mainly land-price gains that John Stuart Mill's generation called the "unearned increment") at the top of the economic pyramid.

    It won't work. It will drive the economy further into debt, shrink the fiscal base and further polarize the economy between rentiers (for whom John Maynard Keynes proposed euthanasia) and wage earners.

    Prof. Michael Hudson is Chief Economic Advisor to the Reform Task Force Latvia (RTFL). His website is michael-hudson.com. **A shorter version of this post appeared on Counterpunch.

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  • The Coming European Debt Wars

    Apr 8, 2010Michael Hudson

    bomb-150Fasten your seatbelts.  The world is in for a bumpy ride on the debt default trail.

    bomb-150Fasten your seatbelts.  The world is in for a bumpy ride on the debt default trail.

    Government debt in Greece is just the first in a series of European debt bombs that are set to explode. The mortgage debts in post-Soviet economies and Iceland are more explosive. Although these countries are not in the Eurozone, most of their debts are denominated in euros. Some 87% of Latvia's debts are in euros or other foreign currencies, and are owed mainly to Swedish banks, while Hungary and Romania owe euro-debts mainly to Austrian banks. So their government borrowing by non-euro members has been to support exchange rates to pay these private-sector debts to foreign banks, not to finance a domestic budget deficit as in Greece.

    All these debts are unpayably high because most of these countries are running deepening trade deficits and are sinking into depression. Now that real estate prices are plunging, trade deficits are no longer financed by an inflow of foreign-currency mortgage lending and property buyouts. There is no visible means of support to stabilize currencies (e.g., healthy economies). For the past year, these countries have supported their exchange rates by borrowing from the EU and IMF. The terms of this borrowing are politically unsustainable: sharp public sector budget cuts, higher tax rates on already over-taxed labor, and austerity plans that shrink economies and drive more labor to emigrate.

    Bankers in Sweden and Austria, Germany and Britain are about to discover that extending credit to nations that can't (or won't) pay may be their problem, not that of their debtors. No one wants to accept the fact that debts that can't be paid, won't be. Someone must bear the cost as debts go into default or are written down, to be paid in sharply depreciated currencies, but many legal experts find debt agreements calling for repayment in euros unenforceable. Every sovereign nation has the right to legislate its own debt terms, and the coming currency re-alignments and debt write-downs will be much more than mere "haircuts."

    There is no point in devaluing, unless "to excess" - that is, by enough to actually change trade and production patterns. That is why Franklin Roosevelt devalued the US dollar by 75% against gold in 1933, raising its official price from $20 to $35 an ounce. And to avoid raising the U.S. debt burden proportionally, he annulled the "gold clause" indexing payment of bank loans to the price of gold. This is where the political fight will occur today - over the payment of debt in currencies that are devalued.

    Another byproduct of the Great Depression in the United States and Canada was to free mortgage debtors from personal liability, making it possible to recover from bankruptcy. Foreclosing banks can take possession of collateral real estate, but do not have any further claim on the mortgagees. This practice -- grounded in common law -- shows how North America has freed itself from the legacy of feudal-style creditor power and the debtors' prisons that made earlier European debt laws so harsh.

    The question is, who will bear the loss? Keeping debts denominated in euros would bankrupt much local business and real estate. Conversely, re-denominating these debts in local depreciated currency will wipe out the capital of many euro-based banks. But these banks are foreigners, after all -- and in the end, governments must represent their own home electorates. Foreign banks do not vote.

    Foreign dollar holders have lost 29/30th of the gold value of their holdings since the United States stopped settling its balance-of-payments deficits in gold in 1971. They now receive less than a thirtieth of this, as the price has risen to $1,100 an ounce. If the world can take that, why shouldn't it take the coming European debt write-downs in stride?

    There is growing recognition that the post-Soviet economies were structured from the start to benefit foreign interests, not local economies. For example, Latvian labor is taxed at over 50% (labor, employer, and social tax) -- so high as to make it noncompetitive, while property taxes are less than 1%, providing an incentive toward rampant speculation. This skewed tax philosophy made the "Baltic Tigers" and central Europe prime loan markets for Swedish and Austrian banks, but their labor could not find well-paying work at home. Nothing like this (or their abysmal workplace protection laws) is found in the Western European, North American or Asian economies.

    It seems unreasonable and unrealistic to expect that large sectors of the New European population can be made subject to salary garnishment throughout their lives, reducing them to a lifetime of debt peonage. Future relations between Old and New Europe will depend on the Eurozone's willingness to re-design the post-Soviet economies on more solvent lines -- with more productive credit and a less rentier-biased tax system that promotes employment rather than asset-price inflation that drives labor to emigrate. In addition to currency realignments to deal with unaffordable debt, the indicated line of solution for these countries is a major shift of taxes off labor onto land, making them more like Western Europe. There is no just alternative. Otherwise, the age-old conflict-of-interest between creditors and debtors threatens to split Europe into opposing political camps, with Iceland the dress rehearsal.

    Until this debt problem is resolved - and the only way to resolve it is to negotiate a debt write-off -- European expansion (the absorption of New Europe into Old Europe) seems over. But the transition to this future solution will not be easy. Financial interests still wield dominant power over the EU, and will resist the inevitable. Gordon Brown already has shown his colors in his threats against Iceland to illegally and improperly use the IMF as a collection agent for debts that Iceland doesn't legally owe, and to blackball Icelandic membership in the EU.

    Confronted with Mr. Brown's bullying -- and that of Britain's Dutch poodles -- 97% of Icelandic voters opposed the debt settlement that Britain and the Netherlands sought to force down the throat of Allthing members last month. This high a vote has not been seen in the world since the old Stalinist era.

    It is only a foretaste. The choice that Europe ends up making will likely drive millions into the streets. Political and economic alliances will shift, currencies will crumble and governments will fall. The European Union and indeed, the international financial system will change in ways yet to be seen. This will be especially the case if nations adopt the Argentina model and refuse to make payment until steep discounts are made.

    Paying in euros -- for real estate and personal income streams in negative equity, where the debts exceed the current value of income flows available to pay mortgages or for that matter, personal debts -- is impossible for nations that hope to maintain a modicum of civil society. "Austerity plans" IMF and EU style is an antiseptic, technocratic jargon for life-shortening and killing impact of gutting income, social services, spending on health on hospitals, education and other basic needs, and selling off public infrastructure for buyers to turn nations into "tollbooth economies" where everyone is obliged to pay access prices for roads, education, medical care and other costs of living and doing business that have long been subsidized by progressive taxation in North America and Western Europe.

    The battle lines are being drawn regarding how private and public debts are to be repaid. For nations that balk at repayment in euros, the creditor nations have their "muscle" waiting in the wings: the credit rating agencies. At the first sign a nation is balking in paying in hard currency, or even at the first hint of it questioning a foreign debt as improper, the agencies will move in to reduce a nation's credit rating. This will increase the cost of borrowing and threaten to paralyze the economy by starving it for credit.

    The most recent shot was fired n April 6 when Moody's downgraded Iceland's debt from stable to negative: "Moody's acknowledged that Iceland might still achieve a better deal in renewed negotiations, but said the current uncertainty was hurting the country's short-term economic and financial prospects."

    The fight is on. It should be an interesting decade.

    Prof. Michael Hudson is Chief Economic Advisor to the Reform Task Force Latvia (RTFL). His website is michael-hudson.com.

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  • Wall Street's War Against Consumers and Labor Heats Up

    Feb 18, 2010Michael Hudson

    wall-street-150Michael Hudson takes on Henry Paulson, Goldman Sachs, and the devastating effects of regressive taxation.

    wall-street-150Michael Hudson takes on Henry Paulson, Goldman Sachs, and the devastating effects of regressive taxation.

    Former Treasury Secretary Hank Paulson wrote an op-ed in The New York Times Monday outlining how to put the U.S. economy on rations. Not in those words, of course. Just the opposite: If the government hadn't bailed out Wall Street's bad loans, he claims, "unemployment could have exceeded the 25 percent level of the Great Depression." Without wealth at the top, there would be nothing to trickle down.

    The reality, of course, is that bailing out casino capitalist speculators on the winning side of A.I.G.'s debt swaps and CDO derivatives didn't save a single job. It certainly hasn't lowered the economy's debt overhead. But matters will soon improve, if Congress will dispel the present cloud of "uncertainty" as to whether any agency less friendly than the Federal Reserve might regulate the banks.

    Mr. Paulson spelled out in step-by-step detail the strategy of "doing God's work," as his Goldman Sachs colleague Larry Blankfein sanctimoniously explained Adam Smith's invisible hand. Now that pro-financial free-market doctrine is achieving the status of religion, I wonder whether this proposal violates the separation of church and state. Neoliberal economics may be a travesty of religion, but it is the closest thing to a Church that Americans have these days, replete with its Inquisition operating out of the universities of Chicago, Harvard and Columbia.

    If the salvation is to give Wall Street a free hand, anathema is the proposed Consumer Financial Protection Agency intended to deter predatory behavior by mortgage lenders and credit-card issuers. The same day that Mr. Paulson's op-ed appeared, the Financial Times published a report explaining that "Republicans say they are unconvinced that any regulator can even define systemic risk. ... the whole concept is too vague for an immediate introduction of sweeping powers. ..." Republican Senator Bob Corker from Tennessee was willing to join with the Democrats "to ensure ‘there is not some new roaming regulator out there ... putting companies unbeknownst to them under its regime."

    Mr. Paulson uses the same argument: Because the instability extends not just to the banks but also to Fannie Mae and Freddie Mac, Lehman Brothers, A.I.G. and Wall Street underwriters, it would be folly to try to regulate the banks alone! And because the financial sector is so far-flung and complex, it is best to leave everything deregulated. Indeed, there simply is no time to discuss what kind of regulation is appropriate, except for the Fed's familiar protective hand: "delays are creating uncertainty, undermining the ability of financial institutions to increase lending to businesses of all sizes that want to invest and fuel our recovery." So Mr. Paulson's crocodile tears are all for the people. (Except that the banks are not lending at home, but are shoveling money out of the U.S. economy as fast as they can.)

    As Mr. Obama's chief of staff Rahm Emanuel put it, a crisis is too good a thing to waste. It's a con man's old trick to pressure the victim to make a decision fast. Having created the crisis, Wall Street wants to use its momentum to knock out any potential checks to its power. "No systemic risk regulator, no matter how powerful, can be relied on to see everything and prevent future problems," Mr. Paulson explained. "That's why our regulatory system must reinforce the responsibility of lenders, investors, borrowers and all market participants to analyze risk and make informed decisions," In other words, blame the victims! The way to protect victims of predatory bank lending (and crooked sales of junk securities) is not new regulations but just the opposite: "to simplify the patchwork quilt of regulatory agencies and improve transparency so that consumers and investors can punish excesses through their own informed investing decisions." Simplification means the Fed, not a Consumer Financial Protection Agency.

    Moving in for the kill, Mr. Paulson explains that the Treasury is bare, having used $13 trillion to bail out high finance in 2008-09. So he warns the government not to run a Keynesian-type budget deficit. The federal budget should move into balance or even surplus, even if this accelerates the rise in unemployment and decline in wage levels as the economy moves deeper into recession and debt deflation. "We must also tackle what is by far our greatest economic challenge - the reduction of budget deficits - a big part of which will involve reforming our major entitlement programs: Medicare, Medicaid and Social Security." The economy thus is to be sacrificed to Wall Street rather than reforming finance so that it serves the economy more productively. It is simple mathematics to see that if the government cannot raise taxes, it must scale back Social Security, other social welfare spending and infrastructure spending.

    What is remarkably left out of account is that today's financial crisis centered on public debts is largely fiscal crisis in character. It is caused by replacing progressive taxation with regressive taxes, and above all by untaxing finance and real estate. Take the case of California, where tears are being shed over the dismantling of the once elite University of California system. Since American independence, education has been financed by the property tax. But Proposition 13 has "freed" property from taxation - so that its rental value can be borrowed against and turned into interest payments to banks. California's real estate costs are just as high with its property taxes froze, but the rising rental value of land has been paid to the banks - forcing the state to slash its fiscal budget or else raise taxes on labor and consumers.

    The link between financial and fiscal crisis - and hence the need for a symbiotic fiscal-financial reform - is just as clear in Europe. The Greek government has pre-sold its tax revenues from roads and other infrastructure to Wall Street, leaving less future revenue to pay its public debt. To cap matters, paying income tax is almost voluntary for wealthy Greeks. Tax evasion is hardly necessary in the post-Soviet states, where property is hardly taxed at all. (The flat tax falls almost entirely on labor.)

    Throughout the world, scaling back the 20th century's legacy of progressive taxation and untaxing real estate and finance has led to a public debt crisis. Property income hitherto paid to governments is now paid to the banks. And although Wall Street has extracted $13 trillion in bailouts just since October 2008, the thought of raising taxes on wealth to pay just $1 trillion over an entire decade for Social Security or health insurance is deemed a crisis that would lead Wall Street to shut down the economy. It is telling governments to shift to a regressive tax system to make up the fiscal shortfall by raising taxes on labor and cutting back public spending on the economy at large. This is what is plunging economies from California to Greece and the Baltics into fiscal and financial crisis. Wall Street's solution - to balance the budget by cutting back the government's social contract and deregulating finance all the more - will shrink the economy and make the budget deficits even more severe.

    Financial speculators no doubt will clean up on the turmoil.

    Michael Hudson is President of The Institute for the Study of Long-Term Economic Trends (ISLET), a Wall Street Financial Analyst, Professor of Economics at the University of Missouri, Kansas City and author of Super-Imperialism: The Economic Strategy of American Empire (1968 & 2003).

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  • State of the Union Part II: Euphemisms, oxymorons and internal contradictions

    Jan 27, 2010Michael Hudson

    Will Obama abandon myths about deficits and social spending? Or is Wall Street still in charge?

    The State of the Union address is in danger of purveying the usual euphemisms. I expect Obama to brag that he has overseen a recovery. But a jobless recovery? What has recovered are stock market averages and Wall Street bonuses, not disposable personal income or discretionary spending after paying debt service.

    Will Obama abandon myths about deficits and social spending? Or is Wall Street still in charge?

    The State of the Union address is in danger of purveying the usual euphemisms. I expect Obama to brag that he has overseen a recovery. But a jobless recovery? What has recovered are stock market averages and Wall Street bonuses, not disposable personal income or discretionary spending after paying debt service.

    There is a dream that what can be "recovered" is something so idyllic as to be mythical: a Bubble Economy enabling people to make money without actually working, by borrowing and riding the tide of asset-price inflation to make capital gains. Harold Ford Jr. writes nostalgically that Bill Clinton's eight years in office created 22 million jobs, "balanced the budget and left his successor with a surplus. This can be done again," --  if only Mr. Obama moves further to the right (which Mr. Ford calls the center).

    Well, no it can't be done again. Clinton's administration balanced the budget by "welfare reform" to cut back public spending. This would be lethal today. Meanwhile, his explosion of bank credit and the dot.com boom (rising stock prices and bonuses without any earnings) fueled the early stages of the Greenspan bubble. It was a debt-leveraged illusion. Instead of the government running budget deficits to expand domestic demand, Mr. Clinton left it to banks to extend interest-bearing credit - debt pollution that we are still struggling to clean up.

    Debts that can't be paid, won't be. So defaults are rising. The question that Mr. Obama should be addressing is how to deal with the excess of debt above the ability to pay -- and of negative equity for the one-quarter of U.S. real estate that has a higher mortgage debt than the market price is worth. If the hope is still to "borrow our way out of debt" by getting the banks to start lending again, then listeners tonight will know that Mr. Obama's second year in office will be worse for the economy than his first.

    How realistic is it to expect the speech to make clear that "we can't go home again"? Mr. Obama promised change. "We simply cannot return to business as usual," he said on Jan. 21, introducing the "Volcker plan." But how can there be meaningful structural change if the plan is to return to an idealized dynamic that enriched Wall Street but not the rest of the economy?

    The promise is that re-inflating prices will help the "real" economy. But what will "recover" is the rising trend of consumer and homeowner debt responsible for stifling the economy with debt deflation in the first place. This end-result of the Clinton-Bush bubble economy is still being applauded as a model for recovery.

    Debt deflation resulting from a distorted "financialized" economy

    Obama faces a problem that he cannot voice politically without offending his political constituency. The Bubble Economy has left families, companies, real estate and government so heavily indebted that they must use current income to pay banks and bondholders. The U.S. economy is in a debt deflation. The debt service paid is not available for spending on goods and services. This is why sales are falling, shops are closing down and employment continues to be cut back.

    Banks evidently do not believe that the debt problem can be solved. That is why they have taken the $13 trillion in bailout money and run. They see the domestic economy as being all loaned up. The game is over. Why would they make yet more loans against real estate already in negative equity, with mortgage debt in excess of the market price that can be recovered? Banks are not writing more "equity lines of credit" against homes or making second mortgages in today's market, so consumers cannot use rising mortgage debt to fuel their spending.

    The President needs a better set of advisors. But Wall Street has obtained veto power over just who they should be. Control over the President's ear time has been part of the financial sector's takeover of government. Wall Street has threatened that the stock market will plunge if oligarch-friendly Fed Chairman Bernanke is not reappointed. Mr. Obama insists on keeping him on board, in the belief that what's good for Wall Street is good for the economy at large.

    But what's good for the banks is a larger market for their credit -- more debt for the families and companies that are their customers, higher fees and penalties, no truth-in-lending laws, harsher bankruptcy terms, and further deregulation and bailouts.

    This is the program that Mr. Bernanke has advised Washington to follow. Wall Street hopes that he will be kept on board. Mr. Bernanke's advice has helped bolster that of Tim Geithner at Treasury and Larry Summers as chief advisor to convince Pres. Obama that "recovery" requires more credit.

    Going down this road will make the debt overhead heavier, raising the cost of living and doing business. So we must beware of the President using the term "recovery" in his State of the Union speech to mean a recovery of debt and giving more money to Wall Street.

    The pretense is that this is subsidizing the middle class, but home buyers are only the intermediaries for government credit (debt to be paid off by taxpayers) to mortgage bankers. Nearly 90 percent of new home mortgages are being funded or guaranteed by the FHA, Fannie Mae and Freddie Mac -- all providing a concealed subsidy to Wall Street.

    Obama's most dangerous belief is the myth that the economy needs the financial sector to lead its recovery by providing credit. Every economy needs a means of payment, which is why Wall Street has been able to threaten to wreck the economy if the government does not give in to its demands. But the monetary function should not be confused with predatory lending and casino gambling, not to mention Wall Street's use of bailout funds on lobbying efforts to spread its gospel.

    Deficit reduction

    It seems absurd for politicians to worry that running a deficit from health care or Social Security can cause serious economic problems, after having given away $13 trillion to Wall Street and a blank check to the Pentagon. The "stimulus package" was only about 5 percent of this amount. But Mr. Obama has announced that he intends on Tuesday to close the barn door by proposing a bipartisan Senate Budget Commission to recommend how to limit future deficits -- now that Congress is unwilling to give away any more money to Wall Street.

    Republican approval would set the stage for Wednesday's State of the Union message promising to press for "fiscal responsibility," as if a lower deficit will help recovery. I suspect that Republicans will have little interest in joining. They see the aim as being to co-opt their criticism of Democratic spending plans. But in view of the rising and well-subsidized efforts of Harold Ford and his fellow Corporate Democrats, the actual "bipartisan" aim seems to be to provide political cover for cutting spending on labor and on social services. Obama already has sent up trial balloons about needing to address the Social Security and Medicare deficits, as if they should not be financed out of the general budget by taxpayers including the higher brackets (presently exempted from FICA paycheck withholding).

    Traditionally, running deficits is supposed to help pull economies out of recession. But today, spending money on public services is deemed "bad," because it may be "inflationary" -- that is, threatening to raise wages. Talk of cutting deficits thus is class-war talk -- on behalf of the FIRE sector.

    The economy needs deficit spending to avoid unemployment and poverty, to increase social spending to deal with the present economic shrinkage, and to maintain their capital infrastructure. The federal government also needs to increase revenue sharing with states forced to slash their budgets in response to falling tax revenue and rising unemployment insurance.

    But the deficits that the Bush-Obama administration have run are nothing like the familiar old Keynesian-style deficits to help the economy recover. Running up public debt to pay Wall Street in the hope that much of this credit will be lent out to inflate asset prices is deemed good. This belief will form the context for Wednesday's State of the Union speech. So we are brought back to the idea of economic recovery and just what is to be recovered.

    Financial lobbyists are hoping to get the government to fill the gap in domestic demand below full-employment levels by providing bank credit. When governments spend money to help increase economic activity, this does not help the banks sell more interest bearing debt. Wall Street's golden age occurred under Bill Clinton, whose budget surplus was more than offset by an explosion of commercial bank lending.

    I worry that tonight's address will celebrate this.

    Michael Hudson is President of The Institute for the Study of Long-Term Economic Trends (ISLET), a Wall Street Financial Analyst, Professor of Economics at the University of Missouri, Kansas City and author of Super-Imperialism: The Economic Strategy of American Empire (1968 & 2003).

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  • State of the Union: Change of Heart Towards Wall Street Needed

    Jan 26, 2010Michael Hudson

    wall-street-150It's make or break time for Democrats. At stake is Obama's credibility as an agent for change.

    wall-street-150It's make or break time for Democrats. At stake is Obama's credibility as an agent for change. Will the party be able to drag Obama away from the Corporate Democrats?

    Massachusetts voters who felt duped by Obama's promise of reform punished Democrats last Tuesday for failing to make a credible start fixing the debt-strapped economy. The President has begged the banks to start lending again. But this means loading the economy down with yet more debt. The $13 trillion bailout was supposed to help banks do this, but they have simply taken the money and run.

    The contrast between Wall Street's recovery and the "real" economy's failure has enabled Republicans to depict Obama and his party as stalling financial reform. Instead of change, voters have seen continuity with rejected Bush policies. Even the personnel remain the same -- like "Helicopter Ben" Bernanke. The Bush-era folks are now back in the White House, and the Democrats have failed every litmus test involving finance, insurance and real estate -- the FIRE sector, which remains the major campaign contributor and lobbyist for both parties.

    The perception that the administration has continued Bush policies has enabled Republicans to position themselves for this year's mid-term elections -- and 2012 -- by reminding voters how they opposed the bank bailout back in September 2008. Now that support for Wall Street has become the third rail in American politics, they may appoint a standard bearer who voted against the bailout.

    This is ironic. George W. Bush ran for president saying: "I'm a uniter, not a divider," and proceeded to divide the country. Mr. Obama promised change, but then decided that he wants to be bipartisan. On Tuesday, he is scheduled to invite Republicans to participate in a joint committee on the budget deficit -- to get Republicans on board for tax increases to finance future giveaways to their mutual Wall Street constituency. They probably will say "no." This should enable him to make a clean break. But then he would not be who he is.

    For opportunists in both parties, the trick is how to wrap pro-Wall Street policies in enough populist rhetoric to win re-election, given that the FIRE sector remains the key source of funding for most political campaigns. The contrast between rhetoric and policy reality is the basic set of forces pulling Wednesday's State of the Union address this Wednesday - and for the next two years. Is Mr. Obama's promise to make an about-face and back financial reform merely rhetorical, or will it be substantive?

    Putting Mr. Obama's speech in perspective

    Spending a year hoping to get Republicans to sign onto health care almost seems to have been a tactic to give Mr. Obama a plausible excuse for stalling on the economy. Subsidizing the debt overhead and the debt deflation that is shrinking markets and causing unemployment, home foreclosures and a capital flight out of the dollar has cost $13 trillion in just over a year - more than ten times the anticipated shortfall of any public health insurance reform or an entire decade of the anticipated Social Security shortfall.

    Not only are voters angry, so are the community organizers and Mr. Obama's former Harvard Law School colleagues with whom I have spoken. Instead of providing help in slowing the foreclosure process or pressuring banks to renegotiate, his solution is for the Fed to flood the banking system with enough money at low enough interest rates to re-inflate housing prices. What Mr. Obama seems to mean by "recovery" is that consumers once again will be extended bubble-era levels of debt to afford housing at prices that will rescue bank balance sheets.

    It is an impossible dream. American workers now pay about 40% of their take-home pay on housing, and another 15% on debt service - even before buying goods and services. No wonder our economy has lost its export markets! Debts that can't be paid, won't be.

    The moral is that the solution to any given problem - in this case, how to make Wall Street richer by debt leveraging - creates a new problem, in this case bankruptcy for high-priced American industry. The cost of living and doing business is inflated by high financial charges, HMO and insurance charges, and debt-inflated real estate prices. This has made Wall Street richer, but as the Chinese proverb expresses the problem: "He who tries to go two roads at once will get a broken hip joint."

    Banks have largely ignored Obama's urging them to renegotiate bad mortgages. Their profits lie in driving homeowners out of their homes if they do not stay and fight. What is needed is to help debtors fight against junk mortgages issued irresponsibly.

    When homeowners do fight, they win. In Cambridge, Massachusetts, I spoke to community leaders who organized neighborhood protests blocking evictions from being carried out. I spoke to lawyers advising that victims of predatory mortgages insist that the foreclosing parties produce the physical mortgages in court. (They rarely are able to do this.) These people feel they are getting little help from Washington.

    And last Friday, Nomi Prins, Rob Johnson and other financial insiders voiced fears that the "Volcker Rule" separating commercial banking from casino derivatives gambling will end up being riddled by loopholes. Financial lobbyists have the upper hand in disabling attempts to reduce their power or even to enact simple truth-in-lending laws.

    Two opposing lines of advice to Mr. Obama

    Over the weekend Sen. John McCain suggested that Mr. Obama should reach out to Republicans in his State of the Union address. Karl Rove advised him to move to "the center" -- what most people used to call "the right".

    Actually, Obama is perceived as being too little for change, too centrist while the economy is polarizing. It certainly seems unlikely that he will now turn on his FIRE-sector backers. His plan is that real estate prices can be re-inflated on enough credit -- that is, enough more mortgage debt -- to enable the banks to work out of the negative equity position into which their loan portfolios and investments have fallen.

    The inherent impossibility of this plan succeeding is the main problem that we may expect from this Wednesday's State of the Union address. Mr. Obama will promise to cut taxes further for working Americans, but his financial policy aims at raise the cost of their housing, their debt service and the cost of buying pensions. Some trade-off!

    America's debt overhead exceeds the means to pay. Rhetoric cannot solve this problem. The solution is too radical for the administration: to write down debts to reflect the capacity to pay under today's market conditions. This means that some banks and creditors must take a loss.

    Obama must now get concrete on change

    For starters, Obama must rapidly push through the Consumer Finance Protection Agency before Wall Street lobbyists wield their bankrolls. There is talk in the press about the Democrats not even pressing forward with the Agency, since they can't get health care done. This is a false worry - or even worse, an excuse to continue doing nothing. Republicans were able to mobilize populist opposition to the health-care bill by representing it as adding to the cost of relatively healthy young adults forced into the arms of the HMO monopolies. But it is much harder for the Republicans to buck financial reform and still appear to oppose Wall Street. Proposing strong legislation against Wall Street will force politicians of both parties to show their true colors. If they don't support the best and most popular law the Democrats can draw up, their populist stance will cease to be credible.

    If the Democrats do not force the debt reform issue, we must conclude that they don't really want financial restructuring. This is what pollster Celinda Lake said last Tuesday: "When six times more people think that the banks benefited from the stimulus than working families, you've got a problem. And it's not just a problem with what Martha Coakley did in her campaign," reported Lake. "Voters are still voting for the change they voted for in 2008, but they want to see it. And right now they think they've got economic policies for Washington that are delivering more for banks than Main Street."

    Mr. Obama needs to signal a change of heart by replacing his failed deregulatory-era trio of Summers, Bernanke and Geithner with advisors who will focus more on the "real" economy than on Wall Street's shadow economy.

    I don't see him doing this. I will discuss how to pierce what I expect to be Wednesday evening's rhetorical fog in Part II of this article.

    Michael Hudson is President of The Institute for the Study of Long-Term Economic Trends (ISLET), a Wall Street Financial Analyst, Professor of Economics at the University of Missouri, Kansas City and author of Super-Imperialism: The Economic Strategy of American Empire (1968 & 2003).

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