Terrific weekend reading with Eric at iTulip interviewing Michael Hudson.
Michael Hudson is Distinguished Research Professor of Economics at University of Missouri, Kansas City (UMKC), a Wall Street Analyst, consultant, and president of The Institute for the Study of Long-term Economic Trends (ISLET). He is also Chief Economic Advisor to the Reform Task Force Latvia (RTFL) and author of America’s Protectionist Takeoff and Super Imperialism – New Edition: The Origin and Fundamentals of U.S. World Dominance
Trouble in Europe, China
Based on an interview with Eric Janszen of iTulip
Courtesy of Michael Hudson
On April 10, 2010 I caught up with Michael Hudson and he was in rare form. Readers know that my personal view is that much of the right wing of the political spectrum doesn’t know what the problem is and all of the left wing, while nailing the problem, doesn’t know how to solve it. No one is too left wing or too right wing to get an interview here.
Interviewer (EJ): Thank you for your time this morning.
Hudson (MH): Glad to be here.
EJ: It’s been a while since I’ve interviewed you so let’s have a wide-ranging discussion today. I want to include your Thursday Financial Times article on the fate of the ex-Soviet debtor nations, the Bank of International Settlement report I sent you on New Europe and other industrialized debtors, and China, and see where it goes. Let’s start with the BIS report.
MH: I skimmed through it quickly, and it’s the same class war junk economics that the Peterson Institute for International Economics (the lobbyist for international banks) and other neoliberal (that is, anti-labor and pro-financial) lobbying organizations have mounted against public obligations to any parties but the Finance, Insurance and Real Estate (FIRE) sector. The aim is to prepare the ground for President Obama’s recently appointed “bipartisan” commission to scale back Social Security and Medicare.
The argument is that these two programs need to be pre-funded, with savings levied regressively in advance, to promote a balanced federal budget. The effect would be to prevent fiscal policy from providing the growth in money and credit that economies need. This would all be provided by private-sector banks – at interest. So recent focus on government “over-spending” (meaning spending on infrastructure and social betterment, as opposed to subsidies and bailouts for the financial sector and its real estate market) is a cover story intended to prepare populations for austerity plans IMF-style.
If you look at the origins of the BIS, you see an irony. It was created as part of the Young Plan back in 1929 to deal in a less financially destructive way with German reparations. As a result of the arguments put forth mainly by Keynes (which I discuss in my history of international trade and financial theories, Trade, Development and Foreign Debt
This broader context of the “ability to pay” is what is needed today from Greece to the Baltics and Iceland. These countries are being directed to pay the financial sector first – international bankers, creditor-nation governments, the IMF and World Bank, and financial institutions – before they spend money on sustaining their own employment and economic growth. So instead of government spending being counter-cyclical as these countries are pushed into debt deflation, they are “pro-cyclical,” that is, squeezing a government budget surplus to pay creditors rather than mounting the public infrastructure and related spending programs that we are seeing in the United States and other countries that put their own populations first.
The twist is that the BIS, Peterson Institute and other creditor-oriented organizations are now telling the United States as well to put creditors first, not the “real” economy. Governments are to run a “balanced budget” (which, former President Clinton told his appreciative Peterson Institute audience, his home state of Arkansas is required to do by constitutional requirement, as are many other U.S. states and cities). They then put forth a junk-economics calculation of Social Security and Medicare claiming that the money will not be there in a few decades under current arrangements.
But these current arrangements insist that money to pay Social Security and Medicare are saved up in advance. This was the trick gimmicked by the Greenspan Commission in 1982-83.This policy demand is hypocritical, unless they say that military wars and bailouts to the financial sector also have to be pre-funded as user fees, levied on the military-industrial complex and Wall Street respectively.
According to their reasoning, America will go bankrupt unless it levies a $30 trillion tax on wealth. Wages have to be cut by 90 percent and assets in the public domain need to be sold off, because on their logic, in order to pay for a $3 trillion war you need to have a $60 trillion savings already pre-saved at 5% interest.
Let’s extend their logic to the $13 trillion bailout last year. America would need to have saved up $100 trillion or $200 trillion in order to yield that much in interest to make this payment. And inasmuch as the bailout was a vain attempt to keep the exponential growth of debt intact, there will need to be more and more bailouts. But all they’re talking about is the rise in medical insurance to the health monopoly.
They’re applying an anti-labor economic logic to Social Security and Medicare, and pro-financial logic to the military and financial bailouts. In both cases it’s labor and industry that must pay.
EJ: Whom does the BIS represent, in your opinion?
MH: They’ve become board of directors for the international financial class, standing up for the banks against labor and now also against the “real” industrial economy. So anything they say should be looked at as class warfare and paid propaganda. If adopted, their recommendations would destroy industry and impose a neo-feudal economy run by creditors. They have no understanding of what credit is, for example. People who do understand the basic monetary principles of credit are considered unfit to work at the BIS. Junk economics likes team players.
EJ: So what is your theory about the role of Simon Johnson who was Chief Economist for the IMF, now a professor at the MIT Sloan School of Management and a member of the CBO’s Panel of Economic Advisers? He was the first of rank to note that our political system as run by a financial oligarchy.
MH: He’s trying to promote monetarism with a friendly face. A lot of the things he writes are correct so he’s sort of the good cop setting things up for the bad cop. But he’s a Senior Fellow at the Peterson Institute, which carefully excludes economists whose idea do not make lobbying points for high finance.
EJ: His blog does sort of read that way, with an “on the one hand this and the other hand that” treatment of Wall Street malfeasance. Not much about the actual workings of the system, but suggestions for reform.
MH: A real reform proposal would have to explain how the banking and credit system actually works. There’s nothing wrong about somebody working for an institution like the BIS or the IMF. I learned what I know about balance of payments working for Chase Manhattan and Arthur Anderson, so I can understand it. But I think that going through the kind of monetarist education that these institutions are looking for these days – perhaps I should say, brainwashing – gives such individuals a set of blinders at the outset. Any proposals for reform that he has will be limited by this set of blinders. He may throw them off, but it’s hard to reprogram one’s mind.
Consider how destructive the IMF’s austerity plans have been. This was apparent thirty years ago. I wrote about it already in the 1960s. Almost everybody has seen these economic sins. The world seems to love a repentant sinner, but wouldn’t it be nice if we didn’t have somebody in an advisory role that didn’t sin in the first place?
EJ: The prescription really comes down to different ways of repaying the debt, right? It’s not on their menu of options to solve the problem of too much debt by simply writing it off.
MH: That’s right. Their assumption is all the debts have to be paid. And they have to be paid by labor and industry. The financial class will use these payments to lend out even more credit to labor and industry, making them even more indebted, causing yet further collapse, requiring larger bailouts, requiring yet further taxes to carry the “socialization” (I should say, feudalization) of bad financial-sector debts.
So the basic modus operandi is self-destructive and will shrink economies. You’re seeing this happening in Latvia and Iceland. Icelandic mothers are telling their kids, “You’d better emigrate because there aren’t going to be more jobs here for the next generation.” Latvian labor has been leaving for the last five years.
EJ: Since the last conversation you and I had, this problem has escalated now to involve larger economies within the European Union – most famously Greece, of course.
MH: I think Greece is a false analogy to Latvia and Iceland. The Greek leadership inherited a military dictatorship that freed the wealthy from having to pay income tax –largely by not enforcing it. Greece is notorious as a place where wealthy people don’t pay taxes. You’ve heard of Leona Helmsley saying only the poor people pay taxes. But in Greece, the doctors don’t, lawyers don’t and many other professionals don’t. There’s little systematic tax collecting there, except for wage withholding. The result is a regressive tax regime.
The IMF and European popular press misrepresent their tax problem as if it were a financial problem. But it’s basically a shift of the tax burden off the higher income and wealth brackets (and especially off real estate) onto labor. This stifles domestic markets and industry. The tax shift off property – along with privatization of public enterprises – raises the cost of living, especially for housing, and hence raises the break-even price of labor to live.
This raises the cost of doing business and makes neoliberalized countries less competitive. Yet creditors are telling Greece that in view of its failure to tax the upper brackets and real estate, it needs to tax labor and the lower brackets all the more to make up for the gap.
What’s wrong with New Europe?
EJ: What was the thrust of your Financial Times article yesterday?
MH: The problem with Greek government debt is that the country is in the euro zone. The problem is more serious is in the post-Soviet economies such as Hungary and Romania, the Baltics, and in Iceland. These New Europe countries have their own local currencies, and their revenues are in these domestic currencies, but their debts are denominated in euros.
The problem is, how are they going to earn the foreign exchange to pay? They can pay the foreign-currency debts – run up mainly by mortgage borrowers in the private sector – only by governments doing the borrowing that property owners no longer are able to do, now that so much of their property is in negative equity.
When you look more closely at cause and effect, it becomes clear that the key to their problem is fiscal policy. They’ve un-taxed property, “freeing” real estate – at the cost of burdening labor and its employers. This unbalanced tax system fostered a real estate bubble while deterring the domestic investment needed to produce exports and balance their foreign trade. In effect, foreign-currency mortgage loans financed structural trade deficits. The financial sector thought that this kind of “equilibrium” was just fine, as currency inflows equaled outflows. Debts were building up – and they were building up in foreign currency – but Swedish banks, for example, gave bonuses to domestic bank officers who managed to keep on lending in this crazy-quilt market.
Now the property bubble has burst, leaving real estate in negative equity. These countries are no longer able to attract the foreign-exchange mortgage loans that financed their trade deficits in the past. This leaves their currencies with no means of support – except to borrow from the EU and IMF. So public debt is being taken on to enable private-sector foreign-currency property debts to be paid.
This is not a sustainable dynamic. In the end the only way to pay off foreign debt is to run a trade surplus to earn the foreign exchange to do this. But Europe and other nations did little to help the post-Soviet countries put in place the means to pay. So their loan program was unproductive, based on loading down un-indebted property with debt, and then hoping to strip assets away.
It used to take an army of occupation to do this, but the dream today is to do this financially, by promoting a neoliberal junk economics that countries adopt voluntarily, and indeed even by democratic vote. And that is where the seeds of a looming geopolitical problem are developing. It is much harder to wipe out official government debts than private ones. Debts to private banks are wiped out when their debtors default.
There may be a transfer of property, but this occurs at a much lower price than the face value of the debt that is due. But if a national government takes on these private debts, and if it owes them to foreign governments or international creditor-nation agencies such as the IMF or EU, then Europe will scream. As Gordon Brown showed in his sissy-fit about Icelandic debts, the demagogic path of least political resistance is to blame the victim for taking short-sighted and dysfunctional advice from greedy, corrupt financial advisors.
This is what today’s financial war against industry, against labor, against the post-Soviet economies, against the Third World comes down to. It is a war against government, against public spending. Its solution to unpayable debts today is to demand that governments sell off whatever assets remain in the public domain. This is the most naked property grab since the Viking invasions. It deserves to be repudiated because it is inherently self-destructive.
Fortunately, an excellent argument is open to debtor countries: “Tell us how solving the problem in your way will enable us to achieve economic balance, without sacrificing our countries to foreign ownership and control, without forcing our labor to emigrate, without shortening our life spans and destroying civil society.”
Europe has a killing reply. “We don’t care.” That is the intellectual state of discussion today. It is intellectual thuggery. But raw material for such arguments is provided by the many thugs sporting PhDs as credentials. Many work for the IMF, EU and BIS as lobbyists, or work in academia simply as useful idiots.
So to answer to your question, here’s the situation: To stave off defaults on foreign-currency mortgage debt, the post-Soviet economies and other debtor countries are taking on “emergency” public debt from official lenders. Government borrowing was low before, because neoliberal policies directed these governments not to help their economies develop in the way that Western European and Northern European governments have done – by public investment in infrastructure, protective tariffs and industrial and agricultural subsidies.
Recent public borrowing from the EU and IMF is not for the purpose of spending domestically, not to help their economies grow by improving basic infrastructure, schools and education, health care and medical services. It is being done merely to support the exchange rate, for no better purpose than to provide central banks to enable domestic real estate owners to pay foreign currency debts to the foreign banks. To do this, the EU and IMF have demanded that Latvia and other governments squeeze out the money to pay by closing down hospitals, emergency medical services, schools and other basic infrastructure.
This is an upside-down fiscal policy. Nations are supposed to put their own economic interest first, not that of predatory foreign lenders.
So you see, this isn’t the Greek problem of an inability to tax the rich. The EU and IMF are demanding that the post-Soviet economies do precisely what got Greece into trouble. The demand is that they not tax their property, but leave its rental income free to be pledged to banks, to attract enough new foreign lending and buyouts to keep on subsidizing their economic dependency and underdevelopment.
EJ: Your suggestion in the Financial Times to ex-Soviet states that owe debts in euros versus their own currencies is to declare their debts in their own currency?
MH: First of all, everybody acknowledges that most post-Soviet currencies cannot be supported at the existing exchange rates. So these currencies are going to plunge. They can plunge anywhere from 40 to 90 percent. And if a currency plunges by that amount – I think Iceland’s currency plunged by almost 70 percent – if the currency plunges while debts are owed in euros or other “harder” currencies, this is will sharply increase the debt service (as denominated in domestic currency). That will force most domestic real estate into default. Again, Iceland is the case study here.
So the first thing that debtor countries should do to reduce the debt burden to foreign central banks is to re-denominate the debts in their own currency. This means abolishing the foreign-currency clause in contracts, just as President Roosevelt abolished the gold clause in the U.S. contracts when he devalued the dollar by 41 percent in 1933.
EJ: But that was done in order to stop a deflation spiral that was occurring here at the time, to purposely produce a surge of import price inflation. In the context of what’s going on here in Latvia and these other countries, wouldn’t such a move produce quite a bit of unwelcome inflation?
MH: There’s going to be inflation in any case. That is the result of the neoliberal policies foisted on the post-Soviet economies, preventing them from investing to achieve self-reliance. When Old Europe expanded and absorbed these post-Soviet economies in a neo-colonialist manner, the latter expected Europe to help them recover in much the way that the World Bank and Marshall Plan aid worked after WWII. That was back when the World Bank was called the International Bank for Reconstruction and Development (IBRD), with some justification.
These economies thought that they would be reconstructed along the lines that had enabled European social democracies to prosper. But what they got was the diametric opposite. Germany’s “economic miracle,” for example, started with the debt cancellation that the Allied Powers proclaimed as part of the monetary reform of 1947. Loans were made to governments to put basic infrastructure in place, while Europe (like North America) had a steeply progressive income and wealth tax.
Today’s Europe has taken debt-free post-Soviet economies and loaded them down with debt – indeed, foreign debt. It is as if they are saddled with reparations as a consequence of losing the Cold War. What they are losing is an economic war of post-Enlightenment policies against everything that the 17th, 18th, 19th and 20th century Western ideals stood for, from John Locke through the Physiocrats, Adam Smith, John Stuart Mill and the Progressive Era.
The aftermath of World War II saw the British and French colonial empires dismantled (largely to absorbed into the U.S. global financial empire, to be sure). But the post-Soviet countries are being treated as European neo-colonies – colonies for Europe’s farm exports and for its bankers as well as for its industrial exporters. And to add insult to injury in the face of this exploitation, the EU has the audacity to call this “neoliberal economics,” as if it were what Adam Smith and subsequent free marketers talked about, rather than the reverse.
The classical liberals wanted to free markets from rentier charges, which they pointed out were technologically and economically unnecessary. Today’s “neoliberals” want to maximize economic rent and unearned income, so as to capitalize it into bank loans and strip revenue and assets from subject economies.
The result is that New Europe was deconstructed. They became post-modern experiments – defining modernity as what the Progressive Era aimed at creating in the Modern Age a century ago. Europe looked at the post-Soviet economies and New Europe not as countries to be helped to grow like European countries did with protectionism, subsidies, especially agricultural protectionism as in the Common Agriculture Policy. Old Europe looked at these nations as a neo-colonial market.
The aim was to prevent their agriculture and industry from developing as rivals, and especially from developing banking on their own. They duly became dependant on European banks. The Baltic countries became dependent on the Swedish banks, while Hungary, Romania and Central Europe became dependent on the Austrian banks, just as in old Hapsburg days.
So when you look at the two post-1991 decades, you see that Old Europe has done little to help New Europe develop. When it lends money to the Baltics and Central Europe today, the aim is to save Swedish and Austrian banks – by imposing onerous taxes on the future labor and industry of these countries. The effect can only be to stifle their recovery in the cradle.
This makes Old Europe culpable for promoting a kind of neoliberalism so right-wing that it never could have gained a foothold from voters in Western Europe or the United States. Latvia, for example, has been saddled with a flat tax on labor of over 50 percent, but less than a 1 percent tax on property. This is crazy by any economic standard! No Western democracy would enact anything like this. It is the most regressive tax system in the world. But this turns out to be Western Europe’s alternative to Soviet Communism!
No wonder nostalgia for the “good old Soviet days” is increasing, mainly among the elderly but now even younger people who think that at least under Communism they had guaranteed work and their basic needs were being met. Populations are asking themselves, “Wait a minute. Do we really want to have a relationship with a European Community that isn’t operating according to the social democratic principles we were led to believe that it was offering?” They see themselves as having been taken over by the financial interests.
This policy invites rejection of debt for the same reason that prompted some 97 percent of Iceland’s voters to get fed up with Gordon Brown’s bullying and reject the financial settlement to which its Parliamentary negotiators had knuckled under. Today, a majority of Icelanders no longer support joining Old Europe. Banks in England and the Netherlands claimed that money is owed, but Icelandic lawyers and economists have good grounds for claiming that they do not owe it.
In Latvia, opposition parties look like they will be voted into national power this autumn behind the Social Democrats, Harmony Centre (representing largely the Russian speaking population – over a third of the total), and nationalist parties in a coalition against the neoliberals. Latvian voters have come to realize that they have been saddled with this junk economics pushed by the Chicago School, by the same people that developed the euro – Robert Mundell and his fellow monetarists whose ideas now are seen to be a travesty of how economies and political society work.
EJ: Why wouldn’t your prescription that Iceland should default on its debt work for Latvia and other countries? Wouldn’t that be less destructive to their economies than inflating the foreign debt away by devaluation? If the currency falls 50 percent, won’t an imported auto double in price?
MH: Your question has two fallacies. First of all, Iceland doesn’t have to default. It doesn’t owe the debt that England and the Netherlands claim is due for the money that they themselves spent to bail out their own domestic depositors in a timely (indeed, pre-emptive) way. These two governments jumped the gun in paying depositors with their own national bank-insurance money rather than adhering to the European Union rules that Iceland had signed along with all the other EU members and associates.
Iceland asked for an honest third-party court to hear the case in and rule. Britain and Holland refused – because they don’t want to lose. Gordon Brown and his Dutch counterparts have acted as if they can just go into a country and threaten: “If you don’t pay us the 5 billion euros we demand, we will blackball you from membership in the European Union.
And we’ll use the IMF to twist your arm. Even though it’s illegal to use a multinational organization for nationalistic ends, that’s what power is all about. And we’ll also make sure that the credit rating agencies lower your bond rating, so that you will have to pay higher interest rates until we wreck you financially and force you to give in. And if you’re late in paying, we’ll charge you a high interest rate for the risk that we might not get paid – and then we’ll make sure we’ll get paid anyway. In fact, we’ll follow up by making you sell off your land and natural resources to our investors at distress prices, and agree not to tax any of our cash-flow by allowing us to claim depreciation, interest charges, exorbitant salaries and financial fees so that there’s nothing less for your tax collectors.”
This may sound almost medieval, but it’s the newest fad in neoliberal financial diplomacy. It’s an attitude that is leading Iceland to look elsewhere than Europe for political and economic alliances. What is happening is neoliberals firing the first shots in a new Cold War. The new war is more financial than military, but it is warfare nonetheless, with equally devastating demographic consequences.
Your second implication above was that devaluation would reduce the foreign debt burden. But the debts of Iceland, the Baltics and other post-Soviet economies are denominated in foreign currency, not their own.
The principal and interest charges of domestic debts in Iceland typically are indexed to the Consumer Price Index, which in turn reflects the exchange rate, because most consumer goods are imported. Iceland’s constitution prohibits this practice, yet it has been going on for decades. The devaluation after autumn 2008 bankrupted many Icelandic homeowners.
People are trying to get this issue into court, but the current Social Democratic coalition is blocking this. So devaluation would increase the burden in their own currency.
EJ: So let’s use a different term other than default. Abrogate? Nullify?
MH: In Iceland they call it the Rule of Law. The Rule of Contracts. Basic contract law.
EJ: Which independent international institution of justice might take this view that you are taking and support Iceland to enforce the rule of law?
MH: Any court in the world that does not have corrupt judges that are bought off. A contract is a contract. The EI rules for bank insolvency and bailouts are clear.
EJ: Where would we find this contract to verify these facts? If we were to scout around on the Internet where would we find the rules that specifically disallow…
MH: I have outlined this in my Global Research articles, which I’ve put on my own website. Banks in Europe, including foreign affiliates, are given three three-month periods to settle their affairs in case of crisis. British and Dutch banking authorities did not honor this rule. They jumped the gun. I’ve put the relevant EU banking paragraphs in my articles.
The Icelandic economist Gunnar Tomasson – a fellow member of the Gang8 (an e- discussion group we organized a decade ago, also linked to from my website) has pointed out that when the IMF reviewed the 2008 banking crisis, it said that if the country’s debt reached certain distress levels (I think, 220 percent of GDP), then the terms of its indebtedness would be reviewed so as to ameliorate the burden.
The Icesave settlement violates this mutual agreement. And as Martin Wolf and the Financial Times editorials explained a few months ago on the day that paper published my op-ed on this, it goes against all the normal rules of diplomacy to try and reduce an economy to the poverty and forced emigration that Iceland is being threatened with.
In the past Iceland has asked America to mediate. For instance, when it had an argument with Britain over fishing territory, it asked the United States to mediate and the U.S. referee came down on the side of Iceland. I think it may already have raised the debt issue with Hillary Clinton, but the State Department didn’t give an answer.
Iceland worries that America might stand up for the financial interests in this case. In any event, no government seems to want to get involved. So Iceland is looking around in Asia and at its nearest neighbors across the North Pole: Russia. And China has the largest embassy in Reykjavík.
EJ: If Latvia and the other former Soviet Republics don’t take the initiative to denominate their debts in their own currency and then devalue, won’t the markets do that for them anyway when their currency reserves get too low to cover foreign debt payments, a la Argentina?
MH: “The market” already has done this – at least, the private-sector market. But the EU and IMF are providing credit to move “against” the market – trying to sustain the unsustainable so as to benefit Swedish bankers for a little while longer. As I think you are suggesting, this almost always is a losing proposition for the country doing the borrowing to try and manage its exchange rate. It only makes things worse.
The problem is what will be the effect of the present interim during which Latvia demurs from facing up to the fact that its debts cannot be paid. It’s folly to wait for creditors to take action in such circumstances, because as the subprime mortgage bubble showed in the United States, their business plan is simply to keep on taking as much as they can, to keep on paying themselves high salaries, bonuses and even hope to retire before the debt pyramid collapses.
There is no way to know when this will occur in advance – until the debtors draw the line. Ultimately, it is up to the debtors to do this.
But Latvians are not looking at economic reality and seeing that there’s no market support for their currency (the lat, or LVL). Their neoliberal government is, in effect, manipulating the currency upward, by borrowing from the European Union and the IMF to “stabilize” it – at the price of destabilizing the “real” economy for years and years.
EJ: Your argument is that they’re just better off denominating their debts in their own currency and devaluing.
MH: Every country needs to owe its debts in its own currency. This is a prime rule of international finance: Never owe debts in a hard currency when your revenue is in a soft one. Otherwise the debt burden will rise and rise, as Latin America’s dollar debt did as the continent devalued at IMF insistence in the 1960s, ‘70s and ‘80s. The wrongheaded IMF “absorption” theory was based on the principle that when you devalue, foreign-currency becomes more expensive.
This is supposed to make imports less attractive. Unless the economy really needs them and doesn’t have much choice. It also is supposed to shift “resources” to the “export sector.” Except for countries that only have raw materials, not a domestic industrial and agricultural export sector. So the idea that devaluation helps is unrealistic for countries that do not employ enough labor to produce the full range of commodities being traded. The actual aim of this junk-economic theory is to keep countries producing raw materials and remaining dependent on foreign agricultural and industrial exports.
When a country devalues, what increases is the foreign-currency debt overhead. Heavier debt service slows economic growth, by diverting spending away from domestic output. The more Latin America devalued, the worse its balance of payments position got. That led to default after Mexico announced in 1982 that it couldn’t pay any more.
EJ: In the case of Argentina the IMF supported their currency in 2000, much as the IMF is supporting Latvia today, because the market won’t. The dot.com crash ensued in the United States, and in 2001 the IMF basically said, “Good luck. You’re on your own.” Then came the debt crisis and default in 2002. Could that happen to Latvia?
MH: Argentina is a special case because it followed nutty advice to use the U.S. dollar for its currency instead of its own. But beyond this monetary problem, its fiscal and property ownership problems go back over a hundred years, and keep reappearing in the same way. It is ruled by a predatory oligarchy. And oligarchies notoriously mismanage economies.
That is why Argentina has devolved from one of the richest countries in the world to one of the poorest. It suffers from a class war between its oligarchy and the rest of the population. This is a much more serious long-term problem than one of international finance. Its roots are in the Spanish conquest and the creation of latifundia. But international finance serves the interests of oligarchies throughout the world, especially as they financialize their wealth.
The IMF was set up ostensibly to make short-term loans to address purely cyclical problems. But for most Third World countries the problem is structural. This also is the case in the post-Soviet economies. The IMF is not set up to deal with this kind of problem. So the argument can be made that just as lenders are irresponsible in not spelling out the dangers to the borrowers taking on sub-prime mortgage loans here in the United States, the IMF has been irresponsible in not explaining to its borrowers how destructive its loans and austerity plans were.
Most borrowers came to realize this. Until about a year ago they were able to escape from the IMF. It was busy closing down its offices around the world. It had only one client left and that was Turkey – and then Turkey finally managed to get out of its clutches. The Prime Minister said that he never wanted anything to do with the organization again. But the collapsing real estate bubble in the United States proved to be a godsend for the IMF.
The global financial bubble burst, and its junk-mortgage lending was what had been providing the foreign exchange to cover the structural trade deficits of the post-Soviet countries, Iceland and a number of other economies. So this trade threatened to collapse unless new unjustified credit could be created to subsidize international dependency patterns.
As economies fell into debt deflation and market shrinkage, the IMF and EU pretended that this was merely a temporary phenomenon – and for their bureaucrats, a fortuitous opportunity to get back into the business of making short-term loans to “rescue” economies. But the reality is that a phase change has occurred.
Failure to recognize this in a timely fashion is leading debtor economies to paint themselves into the political corner of official inter-governmental debt, which is much harder to extricate oneself from than private-sector debt. (I pointed this out in my book Super Imperialism already in 1972, based largely on World War I’s legacy of Inter-Ally arms debts and German reparations debts. Today, the U.S. Government debt to foreign central banks is becoming equally problematic.)
The global Bubble Economy’s collapse triggered a phase change, a change in direction. I think most countries that borrowed from the IMF and EU can see how irresponsible its austerity and devaluation plans were. They’re junk economics. I’ve showed why in my history of theories of Trade, Development and Foreign Debt (new ed. 2009).
Debtor countries on which bad economic advice has been foisted can make the moral argument (and possibly even a legal one) that they should not be held financially responsible for the mistaken economic model that led them to rely on foreign lending rather than developing their own self-reliance. This model led foreign lenders to extend credit without being able to explain how loans – indeed, loans denominated in foreign currency – could be paid, with interest, on an economy-wide basis.
Debtor countries therefore can argue that just as a bank that has made bad loans should be allowed to go under for its shortsighted bad gambles. You creditor-nation governments and you IMF and EU predators should not be repaid for having made loans that we cannot pay in the normal course of living and doing business. You are demanding that we not survive as democratic economies. Your loans are the equivalent of ‘odious debts,’ because they have been made under false pretenses and assumptions. Borrowing-country officials were told that this credit was needed to help our economy, not hurt us.”
So there is in fact a case for reparations here. The problem is that it will now take five or ten times the amount that was lent to enable these financially and fiscally injured economies to recover from the disaster of having listened to IMF-EU junk economics. Yet the IMF and EU are now adding insult to injury in demanding that the Baltics, Iceland and post-Soviet economies make Swedish, Austrian and other banks “whole” on their irresponsibly bad loans.
This is to be done at the cost of drastic cut-backs in domestic public spending, drastic privatization sell-offs that will turn debtor economies into rentier “tollbooth” economies – remitting foreign rent-seeking abroad and making the balance of payments even worse.
It is an old story, one made all to familiar in Third World victims of the IMF and World Bank from the 1960s onward. It should not be repeated in the 2010s. If an attempt is made to do so, then the class war will be back in business – on a global scale.
EJ: This is a very important point for our readers – your point about a phase change and the possibility of a significant structural realignment, not only in the ex-Soviet bloc but possibly within the Euro-zone as well.
MH: The game is over. It’s run its course, in the sense that economies have become fully “loaned up.” There’s no more collateral that is free to be pledged for debt. The rental revenue from real estate has been fully pledged, so that as economies shrink and mortgage lenders pull back, real estate prices are collapsing, leaving negative equity – followed by defaults, foreclosure and a transfer of property from debtors to creditors.
Ever since the post-Soviet states separated from Russia and other Soviet Union members in 1991, they’ve had a structural trade deficit. They have not developed the means to finance this deficit, except in a few areas like Slovakia. Instead of increasing exports to pay for their imports, they have financed their structural trade deficit by borrowing mortgage money – in foreign currency.
The foreign currency inflow for mortgages has been turned over to the central bank, which has used it to pay for converting import payments by domestic buyers into the foreign currency to pay foreign suppliers – and to subsidize capital flight. Supporting the currency enables more of it to be converted into foreign exchange. This is done in exchange for future tax levies (and loss of fiscal autonomy) to pay foreign creditors.
EJ: The IMF is enabling capital flight from the Baltic States?
MH: The main beneficiaries of IMF foreign-exchange support are the recipients of capital flight and debt payment. There is a long history of theorizing about the “capital transfer” problem, from John Stuart Mill’s 1844 analysis of how capital transfers worsen the terms of trade for exports and imports, to the writings of Keynes in the 1920s about the German reparations problem and the capacity to pay.
This school of analysis is antithetical to the junk economics that the IMF promotes and Europe follows. Europe acts as if all today’s financial instability is merely a liquidity problem, aggravated by governments spending too much on labor and social purposes without taxing labor more. According to this combination of equilibrium theory and trickle-down theory, everything can get back to normal if you put the class war back in business. But economies can’t restore a “normal” set of dynamics that was inherently self-destructive and corrosive in the first place. They can’t get back to normal unless real estate prices recover, employment and industrial investments recover, and state and local budgets recover.
But they are not going to. Inasmuch as the last recovery was debt-financed (for instance, by homeowners borrowing against the rising price of their real estate), the banks promise that recovery will come when the governments give them enough bailout money to enable them to start lending again. But banks won’t lend against real estate whose mortgages already exceed the market price. That would be suicidal, and they’re not going to repeat the last bad-loan craze so soon.
The Baltics and other post-Soviet countries – and much of Europe and North America – are in structural trade deficit largely because their regressive tax system, which has become symbiotic with a predatory creditor-oriented financial system. When an economy shifts taxes off property, off the land, real estate, monopolies and financial wealth onto labor and industry, it is “freeing” this economic rent to be capitalized into paying interest on bank loans.
This diverts spending from domestic markets, stifling economic growth. This is so basic and so simple that it’s amazing that the dynamics of debt deflation do not appear either in the academic economics curriculum or in public policy discussion.
Why is the euro falling against the dollar?
EJ: Moving on to the euro zone, are Greece, Spain and Portugal canaries in the euro coal mine? Is it likely that other countries in the Euro-zone are going to have difficulties?
MH: Greece and these other PIIGS countries are in a balance-of-payments crisis because their debts are owed to the German and Dutch creditor “core” of Europe, and to some degree to France. So these nations are at one pole of the euro, and the other countries are at the other pole.
Europe has polarized financially, in the context of an increasingly regressive fiscal policy. The real estate bubble has left Europe debt-burdened, stifling its internal market.
EJ: How do you see the conflict between euro-zone debtor and creditor countries being resolved?
MH: Either the European economy is going to shrink, sacrificing itself to pay its financial overhead, or there will be large defaults that will wipe out large amounts of debt. Something has to give.
If you look at the problem from a balance-sheet perspective, it’s obvious that one person’s debt is another’s savings. So if the debts can’t be paid on the liabilities side of the balance sheet, this means that somebody most lose – somebody on the asset side of the balance sheet. In the first instance, the banks that made the bad loans should lose. But governments are bailing out the banks – and when they do this “at taxpayer expense,” this means that they will have to tax labor and industry to make up the difference – or sell off public enterprises, to new buyers who will put up tollbooths to charge more for access to basic infrastructure.
This will raise the economy-wide cost of living and doing business. That will make matters even worse, because it puts a fiscal overhead in place, on top of the financial overhead and Europe is becoming a very high cost area and that’s what’s leading to the decline of its currency.
EJ: So the weakness that we’re now seeing in the euro is an expression of this concern about a self-reinforcing process? Is there no way out without defaults occurring?
MH: There’s will have to be a restructuring, and it will have to involve writing off bad debts. A lot of debts can’t be repaid. People are walking away from their property – or trying to. The problem in Europe is that mortgage debtors remain personally liable for negative equity, unlike the case in most of the United States.
To save people from being reduced to a lifetime of debt peonage, the debts need to be written down to the market value. And governments must reverse their regressive tax shift off property onto labor. This is largely what “freed” rental income to be pledged for debt in the first place.
Taxes must be shifted back onto land and monopolies – basically the FIRE sector. This means that governments should collect the site-rental value presently pledged to banks as interest.
By promoting a pro-financial, pro-rentier tax policy since 1980, bank lobbyists have painted economies into a fiscal-financial corner that will backfire for banks as governments reverse the legacy of past fiscal malstructuring. If they now levy a realistic land tax on property rent, it will be at the expense of banks and lead to yet more loan defaults.
EJ: Who decides who is going to win the political battle shaping up here between the PIIGS and their creditors within the structure of the euro?
MH: I guess, whoever has the most guns politically. The Greeks are out on the streets, and so are the French. They’re not like Americans. They’re protesting and the class war is back in business. Same thing in Ireland.
EJ: My French friends tell me they’re barbarians over there. We’re very civilized here in the United States.
MH: That’s our problem, as Freud explained in Civilization and its Discontents.
EJ: I remember reading that book in college. He explained the conflict between the demands of society for individuals to stifle the animalistic behavioral foundations of human nature. Is there a way to diffuse the conflict? A muddle-through option? The IMF has been in and out of the Greek rescue.
MH: The IMF cannot be part of the solution. It’s part of the problem. And the EU’s pro-financial leadership is just a much a problem, especially since the Lisbon agreements.
If a Greek-type problem came up a century ago in, say, Latin America, the United States would send in the marines and occupy the custom’s houses. That was at a time when governments raised most of their taxes from customs on imports and exports. The marines would collect it and pay the creditors. But what are creditors going to do today? The Germans aren’t going to take over Greece. So who will act as the equivalent of the Internal Revenue Service to collect the money? There is no European parliament with power to assess overall Eurozone taxes.
Instead of promoting a military dictatorship, as the colonel powers did in the old days, it is necessary to elect a popular government that would tax the rich. I don’t see the Germans doing that. EU creditors support the right wing, not the left wing. Banks probably are frightened at the thought of a non-neoliberal government collecting taxes progressively to balance the budget and pay public debts. So it’s become a right-wing versus left-wing problem. But Europe lacks a left wing to make this case very well.
The Social Democrats have all but abandoned their original economic reform policies. They now are concerned more with political and social issues than economic ones. So there isn’t really a party in Europe that is taking the side of progressive economic policies. The “left” has left economics and finance, debt and credit policy, to the right wing to discuss among its own ranks rather than making it a left-wing topic as it was a hundred years ago.
EJ: Isn’t that something of a global phenomenon?
MH: Yes.
EJ: I don’t see it as being terribly different here in the United States.
MH: Or in Labor Parties all over the world. Those in Australia and New Zealand led the privatization sell-offs and shifted taxes to favor the financial sector. Financial analysis has been “decoupled” from the social analysis that characterized social democratic and labor parties at their outset a hundred years ago.
Editor’s Note: iTulip.com has for more than a decade stood for open dialogue among differing viewpoints on the economy and markets. We consider ourselves neither left-wing nor right-wing, and seek to avoid the echo chamber effect produced on sites that voice a single perspective or represent a narrow set of interests. We believe that a healthy political economy results from a fair battle of beliefs between opposing belief systems represented by competing interests. If the dialogue is dominated or controlled by either one side or the other, a disaster of
China’s next phase
EJ: It seems to me there are a number of trends converging over the next few years. You’ve brought up quite a few of them, including significant changes going on in China. We’re starting to see some of that exhibited in changes in policy. Do you see anything changing significantly politically in China over the next few years?
MH: For starters, there’s going to be a generational change. Younger leaders will take over. But the generational change will not only be demographic, it will be a geographic shift away from Shanghai toward Beijing and the centre of the country – to Nanjing, Wuhan and the South, and further inland, which is not so financially tied to the East, nor as neoliberal.
Neoliberalism was a tactic to break down the old bureaucracy. And in that sense it succeeded in building up China remarkably – much more successfully than in Eastern Europe. When I was in China last fall, I felt I was stepping into the future when I’d go to a train station, take a train or drive into the city. So it’s done a lot. But it is now time to proceed to the next stage.
Now that China has over $2 trillion in foreign exchange reserves, it can operate without trying to accumulate more. It had to get to this point for defensive reasons, to prevent a recurrence of the Asian financial crisis of 1998 being directed at it.
EJ: What is China’s next stage of development?
MH: It’s moving from an export-oriented stage more toward developing the internal consumer market. It’s doing that for two reasons: one, the export market is drying up with the movement of the Western economies into depression and debt deflation; two, so that China’s enormous productive capacity can be deployed to produce continued growth. How is China going to sell this output if not to its domestic market?
EJ: One of the trends in China for the last thirty years is a decrease in personal consumption. Do you think that’s going to reverse?
MH: People have been saving a lot. In Beijing I noticed a tendency toward conspicuous consumption by buying automobiles. This threatens to cause traffic and pollution problems. Obviously the government wants people to earn money and spend it, but if millions of Chinese buy and overstuff the country with autos, they will replicate U.S.-style urban sprawl.
Another problem is agriculture. China has focused on industrial modernization. Agricultural modernization has not kept pace. There isn’t really a national plan to say, which land should be used to grow crops, and which is marginal land that can be used for real estate development and commercial construction. There has not been a ranking of what lands should be agricultural and what shouldn’t.
The result is that just as has occurred in the United States, local fortunes can be made on re-zoning land from agricultural to commercial and residential. This threatens to squeeze agriculture.
Another potential problem is that they’ve begun to buy Monsanto’s genetically modified seeds. This is not my specialty, but agriculture’s biotechnology revolution has become problematic enough to prompt a lot of people talking about it in China. The underlying problem is whether agricultural productivity can be raised by as much has occurred in the United States since the 1930s, and in Europe since the Common Agricultural Policy.
Farm productivity in the United States rose even more than industrial productivity for many decades. That should happen in China too, except that this time it’s unlikely that productivity can be increased by pesticides and herbicides, chemicals and special seeds as in the past.
EJ: Isn’t there a major difference between China’s land development now and ours earlier, in that the land there is owned by the government and leased out while the land here was privately owned. Does that make the process very different? Also, doesn’t China’s way of promoting land development promote a property bubble?
MH: Land is owned by the government, but it is leased out, usually for thirty years. What is needed is for the leases to be drawn up so that the government can collect the rental value of the land site. You want to encourage the build-up of commercial construction. You want buildings and housing, and you don’t want to tax capital investment.
But it’s basic classical rent theory for the government to collect the increase in land value. The classical economists viewed the as the proper source of taxation But that isn’t how the long-term leases of the Chinese government have been written. So there’s been a huge increase in untaxed land value that does not accrue to the government. John Stuart Mill called this increase in untaxed land value the “unearned increment” that landlords make in their sleep. What has happened is that the land rent – created largely by public spending and prosperity – is being pledged to the banks as buyers borrow to buy it.
This is the problem that the West and the post-Soviet economies suffered with their real estate bubbles. It is capitalizing what should be government revenue into private financial revenue.
EJ: My next question has two parts. The first is whether you believe that the renminbi will rise when China eventually allows it to float, as everyone seems to expect. Second, do you think their decision will indicate a policy shift from an export-oriented to a more internal demand based economy?
MH: That’s how the American press is depicting it, but not the Chinese. U.S. press reports – and your question – are written almost in a vacuum when it comes to Chinese politics and economic choices. They don’t want to re-value their currency under conditions where this would involve taking a loss on their huge investments in dollars. They have really $2 trillion in foreign exchange and they’ve lost faith, like everybody, in foreign currency.
They tried to shift, to protect themselves by diversifying out of the dollar into euros and sterling and promptly the euro and sterling plunged against the dollar. So they lost money there, too. I’ve urged the government not to think of it simply of revaluing currency in the current pattern of international exchange.
The problem is that China is dealing with an America that strongly manages its own currency. America accuses China of managing its currency but it’s the United States that’s managing the currency by holding down the interest rate at very low levels in order to reflate the financial markets. Holding it down under terms that the US dollar doesn’t rise to protect the investment.
So China doesn’t want to have to float its currency in the face of other countries managing their currencies against China and under conditions where foreigners have bought into Chinese banking and can become huge gamblers essentially trying to empty out China’s reserves by running raids on the currency. So in order for China to float the RMB there would have to be a political change in the way the international financial system is structured. I’ve urged them to balance the Capital Investment Account, in other words all of the American capital flowing into China, by saying that if the United States refuses to let the Chinese government and agencies buy major American enterprises as Americans have bought outside China from inside China, China should use its dollars to buy out American and foreign investments in China.
So the policy will say, “Okay you won’t let us buy any significant stake in Boeing or other significant companies in America. Fine. We’ll buy out the American manufacturing firms and banks that you’ve set up in China and we’ll pay you the full book value that your corporations report their net worth at.
You’ll get the dollars back and we’ll get rid of the dollars we don’t want and we’ll be back in balance. That way we’ll have Chinese industry for the Chinese and you can have the American industry for the white people, which seems to be how America operates.”
EJ: I’m aware that China doesn’t want to do anything to lower the value of their dollar holdings nor allow the RMB to strengthen, and the US doesn’t want the dollar to strengthen, either. That was one of the major reasons for our buying gold in 2001. Global debt orgies have a way of ending up as currency devaluation orgies, and gold was a way to hedge that. Are you suggesting to them that if US companies refuse to sell holdings in China but that China essentially take them?
MH: They’re very polite. Of course they’ll ask but they’re also smart enough to ignore the response. You can either say, “Yes, please” or “Yes, thank-you” otherwise they’ll assume its an error in translation.
EJ: But won’t that stifle future US investment in China?
MH: I hope so. China doesn’t need American investment in Chinese banks. It doesn’t need Goldman Sachs there. It doesn’t need financial predators. It doesn’t need the kind…
EJ: I was referring to all the U.S. corporations that manufacture the goods there.
MH: The US manufacturers in China don’t pay an income tax over there because China has gone along with the US tax system and permit these manufacturers to operate without declaring a taxable profit. And the reason they do that is they claim they borrowed the money from the parent company or its affiliates to set up a manufacturer there so the American companies there expense their profits in interest charges and appreciation which writes down the book value.
So China can say, “Wait a minute, this whole gimmick was just done to avoid taxes and you actually owe us money. If you don’t pay the taxes you owe I’m afraid we’re going to have to seize your factories for back taxes.” It doesn’t need tax evaders. It doesn’t need financial crooks like the American companies have been behaving there. They’ve behaved abominably there as they have in Iceland and other countries.
EJ: Well, that may be true in some instances but surely that’s not the majority. I’m aware of quite a few US companies that do business in China. The deal has always been, “We’ll come in and set up production facilities there, and in exchange for that we’re going to create high paying jobs and teach you how to organize networking equipment.” The transfer of technological and managerial know-how is a key benefit to China, second only to enabling export-led growth. ?
MH: I don’t doubt that as long as China believes there is a mutual gain in foreign investment it will welcome this. But will cease to do so at the point where it no longer sees a mutual gain – not only a gain on a case-by-case basis, but also on a systemic macro basis. At first, China looked at each investment in terms of whether it would as help the Chinese counter-party.
But now the question is whether the overall pattern of U.S. investment is going to help the overall Chinese economy, not merely one firm bringing in a particular technology. (And foreign investment in banking is especially predatory, because it gives foreign-owned banks a free lunch inasmuch as they can create new credit on a computer keyboard and load down domestic real estate with debt.) Now that they’ve elevated their economy’s overall activity, they can afford to look beyond the narrow micro-picture and proceed to place it in a macro-context.
At this point, national long-term economic strategy comes into play.
EJ: Possibly part of their strategy is not to allow their currency to appreciate against the dollar, except gradually over time as part of their policy to restructure their economy to be more internal-demand driven.
MH: There are two traditional reasons for a currency to appreciate. Most discussion in the United States oversimplifies the issue by reasoning as if the balance of payments is only for imports and exports of goods. Most economists shy away from confronting the main dynamic pushing America’s balance of payments into deficit in recent decades: U.S. military spending abroad.
Americans are throwing off dollars by ringing China and Russia with military bases all over Asia. So by financing the U.S. payment deficit – by buying Treasury bonds to finance the federal budget deficit, which itself is largely military in character – China is financing its own military encirclement.
The second reason for the dollar’s weakening is the huge capital outflow from the United States. American money managers are bailing ship like rats, putting their money in Third World countries and trying to move as much into China as possible – largely to gain on the anticipated dollar depreciation against the renminbi.
China can turn around and say, “You’re creating money on a computer keyboard as free credit, and trying to move billions of electronically created dollars into China on a leveraged foreign exchange bet. But we have to earn our foreign exchange by our labor. You’re trying to force our currency up with your own flight capital. This is not a good economic reason for our currency to be forced up. If it rises, it should be for real economic reasons having to do with trade and tangible capital investment, not for a purely speculative wave. That is what caused the Asia crisis in 1997. We’re not going to let it happen again.”
So essentially they’re saying, fool me once, shame on you; fool me twice, shame on me. They’re not going to fall for the U.S. currency-raid ploy a second time. So people like the Paul Krugmans and Tim Geithners of the world are being rejected by China’s policy makers. They see them as hatchet men pushing junk economics and they’re not going to fall for it. The words I hear over there are, “These guys are full of shit.”
EJ: I think most people probably forget that during the so-called Asian current crisis, Taiwan and China were among just a handful of countries that were immune because they quickly implemented capital controls.
MH: Malaysia did the same thing. Prime Minister Tun Mohammed Mahathir and his advisors prevented foreign speculators from buying domestic currency. As a result, they couldn’t cover their short sales. They sold the currency short, but then they couldn’t buy it to cover their open positions. So it actually was forced up. George Soros claimed (I don’t know if it’s true) that he actually lost money in Malaysia.
EJ: I’m hearing that there is a growing consensus in Asia to start unwinding the large defensive currency reserves that they’ve built up since Greenspan went there in the early 2000s and said: “Here’s how to prevent a recurrence of the Asian crisis, just keep a year’s worth of foreign reserves.”
MH: I can’t tell you the contempt they have for Mr. Greenspan. They realize that what he was telling them was a deliberate falsehood. They know very well that he knows that the purpose of having a country build up reserves is to that provide a pot of gold to be looted by raiders.
EJ: I’m hearing that if there is another similar crisis, every Asian country will just do as Malaysia did in 1998. They’ll all apply currency and capital controls.
MH: Not only capital controls. Any future raid will be regarded as tantamount to military hostility. There will be a political break from the West. They will say, “This is it. We’re instituting the Asian doctrine: Asia for Asia. Get out of here, military bases and all, or we’ll drive you out. If you don’t, we’re going to have to do just what you would have done if we established a military base in Cuba.”
EJ: It sounds to me like you are expecting major geopolitical changes in China and Asia over the next few years.
MH: America is so self-destructive and so dominated by junk economics that when it goes abroad it leaves foreign officials open-mouthed in amazement. Then they realize that these people have been carefully picked precisely because they are so short sighted. America picks diplomats who believe the party line that feeds into its strategy. But it should confine them to the public relations department, not let them operate as people who actually do the thinking about economic policy.
EJ: How do you suppose Geithner is doing on his latest bond sales trip to China?
MH: The first thing they’ll say is, “What do we get in exchange for this?” Their position will be: “Okay, we understand that you want to sell us bonds. On the one hand you’re telling us to raise our exchange rate. But if we do this, we will lose the purchasing power of these dollar-denominated bonds.
So you’re actually telling us that you want us to take a loss on them. You want to sell us bonds that will depreciate by maybe 25 or 30 percent in our currency if we revalue. Okay, we can live with that. What’s the quid pro quo? What’s your offer? Are you going to give us your military basis in Asia? Will you accept an Asian version of the Monroe Doctrine and stay out of Asia and keep to the Caribbean and Latin America? Or will you perhaps sell us our commanding heights, your best technology and give us a stranglehold on your public infrastructure so that we can raise access toll fees like your guys do in debtor countries that you force to privatize?”?
EJ: What do you think the offer actually is?
MH: I think the U.S. response is jaw-dropping confusion. Cognitive dissonance: “Gee, we didn’t think of that. You mean you want something in exchange?”
The Asians must be laughing at this point. “Well, that’s just how it works. When you want us to give you money and take a guaranteed loss on something that we buy, you’re supposed to give us something in return. Isn’t that how the world is supposed to work?” The Americans don’t seem to be aware of that. Their diplomacy is narcissistic, predatory and bullying.
EJ: Is this speculation, or is this what you’re hearing??
MH: Everybody I talk to asks what the Americans are going to offer. In the press there, and just in talking to normal people, their view of the situation is (1), “America wants us to raise the currency. That means our dollar holdings are going to be worth less in renminbi.” And (2), “They want us to buy dollars, but they’re not giving us a guarantee in renminbi.
In fact, they are guaranteeing that these dollars that they want us to buy are going down in value as the dollar depreciates.”
EJ: Isn’t it logical for China to demand a higher interest rate?
MH: More important than the interest rate is a foreign-currency guarantee. It should say, “Look, if we buy bonds, forget the interest rate. Of course we want the kind of interest you paid in the 60s. We want 6 or 7 percent interest but we also want to get a guarantee.” Now the problem is, what can America guarantee the dollar debt? You can’t guarantee it against euros and sterling because they’re going down. Do you guarantee it against gold?
EJ: Reverse the 1971 U.S. default on gold obligations? Not likely. With trillions of dollars in claims against dollar debt, gold would rise to $10,000 in an hour.
MH: That’s the problem. There isn’t any stable measure of value any more. This means that there is no point in accumulating international reserves, if whatever currency you buy is going to go down in value. When China sought to diversify out of dollars into euros and sterling, both these currencies collapsed as a result of the PIIGS crisis and associated currency raids.
EJ: Might China demand some kind of formula that ties the interest rate to the exchange rate?
MH: That’s what commercial banks insist upon in Iceland and other countries, so sure, it would be logical. But I don’t think the American government is going to give in on that. It’s beginning to look as if America only does that for white people – Europe in the 1960s, for instance.
EJ: I see. Well, I really appreciate your time. I think I’ve taken just about an hour of it. Is there anything that we did not cover that you’d like to add?
MH: The point I made at the beginning of your interview. The opening shots in this new financial class warfare – demanding that governments save in advance to finance their payouts for Social Security or Medicare – is about as economically nonsensical as saying that governments need to save up in advance to finance a war or bail out banks.
When you have economic nonsense, there almost always is a special interest at work. And in this case the special interest is high finance – and wealth at the top of the economic pyramid, because the money “saved” will be lent to the government to cut taxes on property and on the upper income and wealth brackets.
So warnings about Social Security and Medicare are just a cover story for shifting the tax system into the kind of regressive structure that we’ve seen the neoliberals apply in the Baltics and other post-Soviet states.
There would not be a fiscal problem if medical insurance and Social Security were financed on a pay-as-you-go basis as is done in Germany, financed out of progressive income taxation. What the bank lobbyists are talking about is a rejection of the progressive tax philosophy that guided countries throughout the 20th century. So what actually is at issue is whether the vested interests can fight back against the past few centuries of classical political economy – the “original” liberalism – and Progressive Era reforms to reverse the course of economic civilization.
The financial sector knows whatever the tax collector relinquishes is free to be paid out in the form of interest to the creditors and the bankers. This is part of the self-destructive direction in which Western economies are going in general. It is destroying these economies. Right-wing rhetoric blames foreigners – Japan in the 1980s, China today – when they take measures to avoid the self-destruction that is now called “socialism” in America – socializing the losses and privatizing the profits and capital gains (and untaxing them). As neoliberal policies impoverish America, the parties doing the impoverishing try to distract attention to an anti-foreign reaction instead of a perception that America has been going down the wrong track since 1980.
EJ: I’ll leave you with one final question. From talking to folks who are trying to figure out what to do with their money, I observe that they want to put it into countries that were previously associated with political instability, high inflation, and over indebtedness, into so-called emerging markets. And now that the U.S. and the Western economies are the debtors we’ve kind of traded places with many of these other countries and so money is flowing out of the U.S. and into Brazil and places that have managed their economies over the last ten years considerably better than the U.S. has. Do you agree with that? And do you see that as a long-term trend?
MH: That’s certainly happening. You can look at the Treasury Bulletin each month and see the outflow of funds from the United States. But when private investors put their money abroad, the recipients of their funds turn their dollar receipts into domestic currency through their own central banks, which end up with these dollars. So this investment outflow that you’ve explained – quite reasonably from the point of view of the American investor – ends up being recycled by foreign central banks. They buy dollar bonds from the Treasury.
This enables it to further avoid taxing wealth, postponing the day when the United States returns to the progressive kind of tax system that made America rich for so many centuries. The “solution” to the problem that U.S. private investors face – how to make more money by investing abroad – aggravates the American fiscal problem. And in the meantime, it creates a global dollar glut.
EJ: A number of unsustainable trends are due to resolve themselves one way or the other over the next few years.
MH: Yes.
EJ: Very, good Michael. We may not always agree, but I can always count on you for a highly informed and thought-provoking discussion. Very much appreciate your time.
MH: Thank you, Eric.
itulip Latvia and China, May 3 (orig. April 13), 2010
See also: The People v. the Bankers
And several books by Michael:
