Financial Interests Dictate Sovereign Policy

by Michael Hudson

Interview with Michael Hudson,
Eleftherotypia, Sunday December 12, 2010.

1. A recent article of yours, “Schemes of the Rich and Greedy,” cites the bailouts in Europe among such schemes. What are the main faults with bailouts, and for whom are they designed?

The financial sector is trying to get politicians to siphon off money from labor and industry to pay bankers. This will impede capital formation and living standards.

The banks misrepresented the real value of balance sheet and hence what they really were owed under actual market conditions. Now that they have taken the money and run, the «real» economy is being told to pay the off their bad loans. The arrogance of this demand prompted Angela Merkel to ask why governments – meaning «taxpayers» – should pay for bad bank loans and corrupt financial dealing.

Nice try if bankers can get away with it! But I’m glad to see Germany opposing the EU proposal to double its bailout fund.

2. You have written that “Latvia has become a testing ground for how far living standards can be depressed, how steeply an economy can be taxed while removing public social support in the face of a wealthy kleptocratic class at the top.” Do you think the same is intended for Greece, Ireland and any other “PIG” that may see its fiscal affairs fall into the control of the EU and IMF?

Foreign bankers are urging Greece “Why can’t you be like Latvia and sacrifice your economy for our benefit?” The reality is that paying creditors under these conditions is like paying tribute to a power that has conquered you militarily.

Fortunately, labor in most of Europe is much less passive than in Latvia. The post-Soviet economies have little labor union tradition, and politics are largely ethnic. As a result of the oppressive Stalinist era bringing in Russians to replace local middle class professionals in the 1950s, the ruling neoliberals have been able to turn the frustration of voters mainly against Russian-speakers rather than at what is the most anti-labor, pro-property tax regime in history.

The rest of Europe now has the bad tax and financial policy of Latvia and the Baltics before its eyes as an object lesson in what to avoid. When the neoliberal bubble burst, Latvia’s government borrowed from the EU and IMF on terms that impose such deep austerity that the economy has plunged by over 20% and unemployment is rising, while the flat-tax rake-off on wages and salaries has now been jacked up to 68%. Over 12% of the population is now working abroad. They send home what they can to help their families survive.

So rather than being a model to emulate, Latvia shows what is wrong with the neoliberal policy that bankers are telling other countries to adopt. It’s not a bailout of the economy, but of an economic strategy that threatens to make economies poorer.

3. How do you explain the IMF’s role in Europe’s debt crisis? Is it that the EU lacks the technical expertise to deal with sovereign debt issues, as some have suggested, or because it is a junior partner of multinational finance capital?

What passes for ‘expertise’ is political, not objective and neutral. At the hands of neoliberals, ‘financial expertise’ means calculating how much taxable surplus, disposable personal income, rental income and profits the financial sector can grab for itself.

Real experts would follow the advice that John Maynard Keynes gave in the 1920s regarding German reparations and Inter-Ally debts. It is better to wipe out bad debts than to try to pay creditors at the cost of reducing capital formation, living standards and public spending on education, health care and other basic infrastructure. A wise government would subordinate the financial sector to promote economic growth, capital formation and rising living standards.

The EU and IMF ‘Washington Consensus’ policy was applied to Third World dictatorships in the 1960s, ‘70s and ‘80s under gunpoint, but Europe is freer to choose. To follow ‘expert’ advice as Iceland and Ireland have done quickly turns into an exercise in asset stripping, replacing social democratic government with an extractive financial oligarchy.

4. Is it in Germany’s interest to drive out of the eurozone the fiscally weak countries?

What really is Germany? Its banks? Its industrial exporters? Or is it German labor? Politicians serving the bank lobby take the following position:

Germany has produced great composers, physicists and chemists, and also scholars of classical antiquity. But our bankers are gullible. They were stupid enough to trust Icelandic bank looters, Irish speculators and American junk-mortgage salesmen. So they’ve lost a lot of money. They’ve asked us to pass on their request that you Greeks, Irish and other people tax yourselves to death and wreck your economies so that they won’t have to pay for their naivety by bearing all the cost of their expensive education in how today’s world of financial sharpies really works.

You can’t blame the bankers for trying. But other countries should call their bluff. Germany would be better served helping countries recover from neoliberal fairy tales and to adopt more progressive tax and financial policies. Otherwise, bankers will end up doing at home what they are trying to do to the rest of Europe.

5. Do you see a way out of Europe’s sovereign crisis?

The economic problem is not caused by sovereign debt but by bad bank loans, deceptive financial practice and neoliberal bank deregulation. Iceland’s Viking raiders, Ireland’s Anglo-Irish bank and other foreign banks are trying to avoid taking losses on financial claims that are largely fictitious, inasmuch as they exceed the ability of indebted economies to pay. The ‘crisis’ can be solved by making the banks write down their debt claims to realistic ‘junk’ valuations. There is no need to wreck economies by subjecting them to financial asset-stripping.

In such cases there’s a basic principle at work: Debts that can’t be paid, won’t be. The question is, just how won’t they be paid? As matters stand, countries are being told to subject themselves to massive foreclosure – not only a forfeiture of homes, but of national policy.

In this respect the sovereign crisis is a crisis of sovereignty itself: Who shall be in charge of the economy, its tax philosophy and public spending: elected officials acting in the public interest, or an intrusive financial oligarchy? The EU was wrong to tell governments to pay for following its advice – and pressure – to trust financial crooks and deregulate bank oversight. The European Central Bank should reimburse victimized governments for the bailouts that have been paid. This reimbursement can be done by levying a progressive tax policy and creating a central bank to help finance governments.

The proper aim of a national economy is to promote capital formation and rising living standards for the population as a whole. not a narrowing financial class at the top of the pyramid. So I see two major policies to lead the way out of this mess:

First, shift taxes back onto land and resource rent, and onto financial and capital gains. This will prevent another real estate bubble from being inflated by debt leveraging. By holding down housing prices, it will save labor from having to pay an equivalent amount in income tax. Low real estate taxes (under 1% until just recently) have not saved homeowners money in Latvia. Low property taxes merely have left more rental income to be pledged to banks, to capitalize into large mortgage loans.

Second, de-privatize basic utilities and natural monopolies to save Europe from rentiers turning it into a tollbooth economy. Europe needs a central bank that can do what central banks are supposed to do: create money to finance government deficits. But the European Central Bank and article 123 of the European Constitution as amended by the Lisbon Treaty prevents the central bank from lending to governments. This forces governments to levy taxes to pay interest to banks – for creating electronic credit that a real central bank could just as well create on its own computer keyboards.

Government banking is not necessarily inflationary. It finances what is necessary for economies to grow: investment in infrastructure and capital formation to raise productivity and minimize the cost of doing business.

What turns out to be inflationary is commercial bank lending. It inflates asset prices – unproductively. Banks lend mainly against real estate and other assets already in place, and stocks and bonds already issued. This is unproductive credit, not real wealth creation. The only way to keep this unproductive debt overhead solvent is to inflate asset prices more – by untaxing assets to leave more revenue to pay bankers on exponentially growing debts.

It doesn’t have to be this way. The recent 30 years of financial polarization is reversible. The alternative is to succumb to neoliberal austerity.

  1. Ralph Musgrave says

    Excellent interview with Michael Hudson above, but I have three disagreements / queries.

    1. Hudson rather suggests that bank malpractice is the ONLY problem. I think he should have mentioned loss of competitiveness by PIGS relative to core countries: it’s an additional reason for the deflation being imposed on PIGS. Deflation, at least on the scale currently taking place, is an unnecessarily harsh, as Hudson rightly points out.

    That loss of competitiveness is not easy to solve within the Eurozone. The ideal and almost instant solution would be an effective devaluation of PIG currencies: i.e. cutting ALL wages in Euro terms in those countries, plus raising the price of all goods in proportion to the import content of those goods. Like devaluing a genuinely separate currency, that would involve a slight cut in living standards, but it would not require raised unemployment. That form of devaluation would be a bureaucratic and administrative nightmare to implement, but PIGS are in a nightmare situation anyway. It’s a choice of two nightmares.

    At the moment, all the PIGS intend doing is freezing and/or cutting public sector wages and benefits. That will work eventually – 5 years – 10 years?

    2. Hudson claims that higher property taxes would “prevent” another real estate bubble. OK, that would help, but I doubt it would stop what he calls “American junk mortgage salesmen” in their tracks.

    Another helpful move would be to stop trying to escape recessions with low interest rates. The failure of this policy is now blatantly obvious: the US has ultra-low rates combined with a feeble escape from the recession. Keynes never advocated low rates as the basic anti recessionary tool: he advocated plain simple extra government net spending. And other leading / Nobel prize winning economists advocated likewise. Low rates encourage asset price bubbles.

    3. At the end of the article Hudson makes an excellent point about the desirability of the ECB acting like other central banks. James Saft wrote an article on this point. See:

    Also Warren Mosler has an article on much the same point:

    Why Europe decided the ECB could not act in the same way as other central banks. Was it fear of political pressure being put on the ECB by profligate countries?

  2. DavidLazarusUK says

    Actually higher property taxes and capital gains taxes will make it much harder to inflate asset bubbles, and without such bubbles it is much harder to issue junk loans. If you know that a property bubble is unlikely or impossible you will not be willing to accept a loan that has rising repayments.

    Simple loan ratios such as ten times tier one capital will make it easier block a bank getting over leveraged. It will make it impossible to deceive a regulator as to the leverage of the bank.

    That does not preclude a return to active regulation. A return to proper regulation is essential. Though I can see the US having significant problems as the GOP perpetually appoint regulators that do not believe that their job entails regulation.

    Ending universal banking is also essential. The French and Germans in particular will resist. That will change when there are enough losses from a sovereign default, wiping out the big French and German banks simultaneously. Though with the systemic links that could destroy the big US money centre banks as well.

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