Michael Hudson Addresses Debt Deflation

Michael Hudson in GlobalResearch.ca article Debt Deflation in Europe and America highlights the interview by Bonnie Faulkner with Michael Hudson, on September 2, 2011 (first aired on Pacifica, September 14, 2011),

Mr Hudson relates that the countries that are in trouble were fascist at one point, Spain under Franco, Portugal, Greece under the Colonels.

Right-wing military dictatorships put in place tax systems that favored the rich and avoided taxing real estate or financial wealth. You could think of these tax systems as the Republican Party’s dream, or for that matter that of the Obama Administration’s Wall Street backers. Shifting the tax burden onto labor and industry seems to be the direction in which the world is heading these days.

The problem is that the EU has been turned into the opposite of what it was in the beginning. Back in the 1950s it was created by Social Democrats and Socialists who wanted to save Europe from ever going to war again within its own borders. The left took leadership. But as financial and monetary union has risen to the fore since the 1980s, the continent has become more right-wing. Planning has been shifting out of the hands of government and elected officials into those of bankers, especially through their proxy in the European Central Bank. What now is at issue is whether Europe will be run for the bankers and financial sector or for the population at large. So far, Angela Merkel has worked with Nicolas Sarkozy to try to represent the bankers’ position, not that of political democracy.

If there’s a crisis because of bad fiscal policy stemming from the rich blocking taxation of their own wealth and property Greece and other post dictatorship countries, the solution isn’t simply to lend them enough to subsidy this regressive tax policy. It’s not to tell Greece to sell off the Parthenon and other tourist sites for privatizers to buy on credit and pay the rental value to the banks. It would be a reversal of the past few centuries of European reform to carve up the public domain and sell it to the interests that organize financial backing. This would turn bad fiscal policy into a victory for the privatizers. Europe would go Thatcherite and Blairite. The Greek colonels would have “won the peace.”

The moral hazard problem is that banks, investors and speculators rely on governments to bail out their bad bets that in turn reflect a self-defeating business plan to load economies down with debt and extract the entire economic surplus as debt service and then foreclose and get one’s capital back via privatization sell-offs.

The US economy has been financialized. In the United State last year, 40 percent of corporate profits were made by the banking sector. The rest of the economy is shrinking under the weight of debt deflation —  interest and fees paid to this financial sector.

Germany is the strongest economy because it’s better structured in many ways ,and more industrial .It has a higher proportion of the real economy to GDP, and also is much lowe r-cost, because it hasn’t built financial overhead into real estate and family budgets to anywhere near the extent that has occurred in the United States.

Countries that have let themselves become post-industrial service economies are finding out that if you don’t make things, you can’t live forever by going to Las Vegas. The casino always wins,and today’s casino is Wall Street. It’s a zero-sum game for the economy with the economy’s losses plus Wall Street’s gains netting out to zero. So in economic jargon, the financial sector has become a transfer payment, not playing a productive role.

As long as we’re speaking of Germany, what is good about its economy? Can you describe its social safety net and what you began to say about housing there?

The typical American family spends about 40 percent of its budget on housing.In Germany it’s only about 20 percent.There are a number of reasons for that. For starters, real estate prices are whatever a bank will lend. Easier credit means higher debt leveraging, and hence, higher property prices.

German homebuyers must pay 20 or usually 30 percent of the purchase price down, so they don’t have 100 percent mortgages like there are in the United States.And mortgages are self-amortizing. For renters, there are co-op arrangements for a much larger market supplied at cost, in contrast to the United States, where the rental market is owned by landlords who squeeze out as much as possible over and above the actual cost of maintaining the property.

A German moving to Hamburg or Frankfurt may join a co-op organization and pay perhaps $1,000 or $2,000. Anyone can join. So there’s not much motivation to buy houses as a speculative means, because it’s usually cheaper to rent than to buy – and less effort for upkeep. As a result, there has not been a German financial bubble to bid up prices as has occurred in the English speaking or neoliberalized countries where people have been panicked to buy before prices rise even further beyond their reach.

In the time of Ricardo two hundred years ago, the most important element in labor’s budget was food. He judged wage competitiveness largely by the price of bread. But today, labor costs are set by what it costs workers to buy or live in a home, whose price is set by highly debt-leveraged credit terms. So Germany’s low unit labor costs are not simply the result of high technological productivity. They reflect low housing costs and relatively low social security costs. It hasn’t financialized its economy to anywhere near the extent that the United States has done.

It’s not the kind of class war that people talked about a century ago .It’s fought in the financial arena.The idea is for the big sharks to take the savings of the little savers. They exploit labor not by employing it – as in Marx’s description in Vol. I of Capital – but financially, by loading it down with debt and making labor spend a working lifetime to pay it off. So instead of the wage slavery socialists used to talk about, you have debt peonage today.

Are there similarities between the economic crisis of September 2008 and the present situation?

Yes, we’re still in the aftermath of 2008.Economists are talking about a double dip recession, but we’ve never gotten out of the first crash.The economy has not recovered. The stock market has gone up, because the Federal Reserve has been flooding it and the bond market with liquidity. But employment, living standards and sales are not going up. Housing is still down.So we’re in more than a Great Recession. We’re going into a lost decade.

We’re entering a period where wages will drift downward in a slow crash, because the government is not renegotiating mortgages downward or canceling bad debts.It is not bailing out the cities that are in trouble and there’s a downward financial spiral basically coming from the debt situation.

The question shouldn’t be whether we’re in a double-dip recession, but why a recovery from the crash has not taken place.Why haven’t the bank bailouts created jobs? How could the government create $13 trillion of Treasury and Federal Reserve cash, loans and guarantees to Wall Street for the wealthiest one percent of our population without this trickling down and created jobs?

How do we jump start an economy when 70 percent is consumer spending, but consumers aren’t spending because they’re spending their money to pay off debts taken on in the past, or worried that they may be unemployed?In other words, what has Washington not been doing that it should have been doing? What has it left out of account?

Before President Obama he was elected he said he was going to renegotiate mortgages downward. Butthe banks have not done this.So did he just give up and say, “Well, just forget it”?The Federal Reserve flooded the banks with liquidity, but they sent it abroad. They argue – with good reason – thatthe economy is shrinking too much to qualify for enough loans to borrow its way out of debt.

It should be obvious by now that giving money to the banks doesn’t create jobs for the people. It is mere propaganda tocall the rich “job creators.” They have put in place an extractive financial system that has destroyed jobs. They’re the ones that are closing down the factories and outsourcing American labor.

Are the banks creating a permanent depression?

That’s the outcome of their business plan, which is to take the entire economic surplus in the form of debt service. Banks want to create as much debt as they can.Debt is their “product.” The economy is merely “collateral damage” to a financial dynamic that is impersonal, not deliberate.

Every economy for hundreds of years has seen debts grow more rapidly than can be paid.At a point there’s a crash, which normally wipes out debts.It also wipes out savings on the other side of the balance sheet, of course. But this time the government has tried to keep the debt overhead on the books – and to tax the population to give banks enough to make sure that the rich don’t lose money.Only industry and labor will lose.

The effect will be to de-industrialize the economy even more, because markets shrink without consumer spending. Companies won’t invest, stores will close, “for rent” signs will go up, tax payments to the cities will fall, and municipal employees will be laid off while social services are cut back. The economy will shrink and life will get harder.

Could you explain debt deflation?

Economics textbooks depict people earning income and spending it on the goods and services they produce.This is why Henry Ford said he paid his workers $5.00 a day – so that they could buy the Fords they made. Economists call this circular flow Say’s Law.

But people spend a rising proportion of their income to pay debt service. That is their first charge. Before they decide how much is available to spend on goods and services,they have to pay their credit card debt, student loans, other bank debt, and of course the mortgage. The more they pay the banks, the less they have to spend on goods and services.Business sales shrink, because the banks recycle their interest receipts into even more loans – on even “easier” terms, meaning more debt leveraging. So the “real” economy of production and consumption shrinks while the payments to the financial sector go up.

Financial investors don’t buy many goods and services. They leave their revenue in the financial system, mainly to be lent out on new loans, sent abroad or used for speculation. Debt deflation is what happens when spending is diverted away from buying goods and services to paying debts. The financial sector grows, relative to the “real” production-and-consumption economy. So debt deflation of the underlying economy goes hand in hand with asset-price inflation fueled by increasingly loose credit and steeper debt leveraging.

The Federal Housing Authority is suing the major banks – Bank of America, Chase, Citibank, Deutsche Bank and other big banks.What is the lawsuit about?

These banks misrepresented the junk mortgages that they were making and selling to outside investors.
They packaged mortgages and sold them to pension funds, insurance companies and foreign banks.Ratings agencies bid for clients by agreeing to give junk mortgages AAA ratings – as good as the U.S. Government.But the mortgage lenders and the ratings agencies they hired assured clients that these mortgages were good and could be paid – or at least that the market would continue to rise, so that if there was a default, new buyers would play the role of the proverbial “greater fool” and buy properties being foreclosed.

It turned out that the appraisals were based on unrealistic appraisals and either fake or absent reports on the borrower’s income and hence ability to pay. They were no-documentation loans, and the biggest banks have turned out to be running a fraud.Bill Black has written more on this than anyone else at the University of Missouri in Kansas City.

By the way – if we’re talking about debt deflation and other financial issues, there’s a UMKC economic blog, called New Economic Perspectives. Prof. Black and I (and others) write about how the financial sector has become what he calls criminogenic. In other words, it’s been criminalized, and bankers have run what he calls “control fraud.” The economy’s largest financial market, real estate mortgage lending, turns out to be based on crooked real estate brokers, appraisers, underwriters, ratings agencies and so9 forth.Right down the line almost everybody’s been engaged in a gigantic fraud that’s helped inflate the real estate bubble.Whereas when similar fraud happened in the 1980s with the savings and loan associations thousands of people went to jail, nobody’s gone to jail yet. Hardly anybody’s been arrested. And yet they’re on a much larger scale than Bernie Madoff.

The real estate bubble would have developed in any event, simply because of the exponential financial dynamics at work and the increasing tax favoritism for real estate, taxing labor and industry rather, than land rent.

If people want to read about Modern Monetary Theory, where would they go on the Internet? To the UMKC (University of Missouri-Kansas City) economics blog: New Economic Perspectives. Most of my articles are posted there. Another good source is Yves Smith’s Naked Capitalism, and also the Levy Institute.


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