Challenging the Model of the North
By MICHAEL HUDSON
Toward what goal is the world economy steering?
That obviously depends on who is doing the steering. It almost always has been the most powerful nations that organize the world in ways that transfer income and property to themselves. From the Roman Empire through modern Europe such transfers took mainly the form of military seizure and tribute. The Norman conquerors endowed themselves as a landed aristocracy extracting rent, as did the Nordic conquerors of France and other countries. Europe later took resources by colonial conquest, increasingly via local client oligarchies.
Today, financial maneuvering and debt leverage play the role that military conquest did in times past. Its aim is still to control land, basic infrastructure and the economic surplus – and also to gain control of national savings, commercial banking and central bank policy. This financial conquest is achieved peacefully and even voluntarily rather than militarily. But the aim is the same: to make subject populations pay – as debtors and as dependent junior trade partners. Indebted “host economies” are in a similar position to that of defeated countries. Their economic surplus is transferred abroad financially, while locally, debtors lose sovereignty over their own financial, economic and tax policy. Public infrastructure is sold off to foreign buyers, on credit and therefore paying interest and fees that are expensed as tax-deductible and paid to foreigners.
The Washington Consensus applauds this pro-rentier policy. Its neoliberal ideology holds that the most efficient path to wealth is to shift economic planning out of the hands of government into those of bankers and money managers in charge of privatizing and financializing the economy. Almost without anyone noticing, this view is replacing the classical law of nations based on the idea of sovereignty over debt and financial policy, tariff and tax policy. Ideology itself has become an economic weapon. Indebted governments have been told since 1980 to sell off their public infrastructure to foreign investors. Extractive “tollbooth” charges (economic rent) replace moderate or subsidized public user fees, making economies less competitive and painting them even more into a debt corner as the surplus is transferred abroad, largely tax-free.
What the world is experiencing in the face of today’s globalism is a crisis in the character of nationhood and economic sovereignty. Bankers in the North look upon any economic surplus – real estate rent, corporate cash flow or even the government’s taxing power or ability to sell off public enterprises – as a source of revenue to pay interest on debts. The result is a more debt-leveraged economy – in all countries. Foreign investment, bank lending, the privatization of public infrastructure and currency speculation is now viewed from this bankers’-eye perspective.
There is one great exception to relinquishing national policy to foreign control: the United States itself is by far the world’s largest debtor economy. While mobilizing creditor power to force other debtors to privatize their public sectors and acquiesce in a one-sided U.S. trade protectionism, the United States is the only nation able to issue its own currency (Treasury debt) and international bank credit without limit, at a lower interest rate than any other country, and even without any foreseeable means to pay.
This double standard has transformed the character of international finance and the meaning of capital inflows. Money no longer is an asset in the form of gold or silver bullion reflecting what has been produced by labor. Money is credit, and hence finds its counterpart in debt on the liabilities side of the balance sheet. Since the United States suspended gold convertibility of the dollar in 1971, international money – the savings of central banks – has taken the form mainly of U.S. Treasury debt, that is, loans to the United States to finance its twin balance-of-payments and budget deficits (both of which are largely military in character). Meanwhile, domestic commercial bank credit takes the form of private debt – mortgage debt, corporate debt (increasingly for debt leveraged takeovers), and even loans for speculation on financial derivatives and currency gambles.
Little bank credit has gone to finance tangible capital investment. Most such investment has been paid for out of retained business earnings, not bank loans. And as banks and brokerage houses have financed corporate takeovers, the new buyers or raiders have had to divert corporate cash flow to paying back their creditors rather than expanding production. This is how the U.S. and other economies have become financialized and post-industrialized. Their experience should serve as an object lesson for what Brazil and other countries need to avoid.
U.S. bank lending has been the major dynamic fueling a global inflation of real estate, stock and bond prices, bolstered over the past decade by European bank lending. Dollar credit (like yen credit after 1990) is created “freely” without the constraint that used to occur when capital outflows forced central banks either to raise national interest rates or lose their gold stocks. In fact, any economy today can create its own domestic credit on its own computer keyboards – those of its central bank and commercial banks. Under today’s conditions, foreign loans do not provide resources that host countries cannot create for themselves. The effect of foreign credit converted into domestic currency is merely to siphon off interest and economic rent.
It is not widely recognized that most commercial bank loans merely attach debt to existing assets (above all, real estate and infrastructure) rather than being invested in creating new means of production, or to employ labor, or even to earn a profit. Banks prefer to lend against assets already in place – real estate, or entire companies. So most bank loans are used to bid up of prices for assets, especially those whose prices are expected to rise by enough to pay the interest on the loan.
The fact that bankers can create interest-bearing debt on computer keyboards with little cost of production poses the question of whether to leave this free lunch (economic rent) in private hands or treat money creation as a public “institutional” good. Classical economists urged that such rent-yielding privileges be regulated to keep prices and incomes in line with necessary costs of production. The surest way to do this was to keep monopolies in the public domain to provide basic services at minimum cost or for free while land taxes and user fees could serve as the main source of public revenue. This principle has been flagrantly violated by the practice of erecting privatized “tollbooths” that extract rent revenue without a corresponding cost of production. This has been done in a way that benefits only a select few.
The unchecked explosion of global credit and debt – and hence, pressure to sell off natural monopolies in the public domain – is largely a result of the credit explosion unleashed after gold convertibility ended in 1971. The ensuing U.S. Treasury-bill standard left foreign central banks with no vehicle in which to hold their international reserves except loans to the U.S. Treasury. This gives the U.S. balance-of-payments deficit a free ride, which translates into a military free ride. After the Korean War forced the dollar into deficit status in 1951, overseas military spending throughout the 1950s and ‘60s equaled the entire U.S. payments deficit. The private sector was almost exactly in balance during these decades, while U.S. “foreign aid” actually generated a balance-of-payments surplus, as a result of aid tied to U.S. exports rather than to the needs of aid-recipient countries.
While other countries running trade and payments deficits must increase their interest rates to stabilize their currencies, the United States has lowered its interest rates. This has increased the “capitalization rate” of its real estate rents and corporate earnings, enabling banks to lend more against higher-priced collateral. Property is worth whatever banks will lend against it, so the U.S. economy has been able to use the dollar standard’s free ride to load itself down with an unprecedented debt overhead – an overhead that traditionally has been suffered only by countries fighting wars abroad or burdened with reparations payments. This is the Treasury-bill standard’s self-destructive blowback.
It is an object lesson for Brazil to avoid. Your nation today is receiving balance-of-payments inflows as foreign banks and investors create credit to lend against your real estate, natural resources and industry. Their aim is to obtain your economic surplus in the form of interest payments and remitted earnings, turning you into a rentier tollbooth economy.
Why would you need these “capital inflows” that extract interest, rents and profits as a return for electronic “keyboard credit” that you can create yourself? In today’s world, no nation needs credit from abroad for domestic-currency spending at home. Brazil should avoid letting foreign creditors capitalize its economic surplus into debt service and other payments.
The way to avoid this fate was outlined from the French Physiocrats and Adam Smith through John Stuart Mill and Progressive Era reformers: by ending the special privileges bequeathed by Europe’s military conquests (privatization of land rent), and by collecting “free lunch” rentier income as the tax base to save it from being privatized and capitalized into bank loans. Taxing land and resource rent lowers the cost of living and doing business not only by removing the tax burden on labor and industry, but by holding down housing and real estate prices, because whatever the tax collector relinquishes is available to be pledged to carry bank loans to bid up property prices.
In the 19th century the American System of political economy was based on the perception that highly paid labor is more productive labor, such that well-educated, well-fed and well-clothed labor undersells “pauper” labor. The key to international competitiveness is thus to raise wages and living standards, not lower them. This is especially the case for Brazil, given its need to raise labor productivity by better education, health and social support systems if it is to thrive in the 21st century. And if it is to raise capital investment and living standards free of debt service and higher housing prices, it needs to prevent the economy’s surplus from being turned into a “free lunch” in the form of land rent, resource rent and monopoly rent – and to save this economic surplus from bankers seeking to capitalize it into debt payments. This is best achieved by taxing away the potential rentier charges that turn the surplus into unnecessary overhead.
But because the wealth of nations is now calculated from the banker’s perspective, surplus income is viewed as potentially available to capitalize into debt service. Rather than using the surplus to invest in capital formation and public infrastructure, the distinguishing characteristic of our time is financialization – the capitalization of the economic surplus (corporate cash flow, real estate rent and other economic rent, and personal income over and above basic living costs) into interest payments for bank loans.
This is the business plan of bank marketing departments and is a far cry from what Adam Smith wrote about in The Wealth of Nations. Loan officers see any net flow of income as potentially available to be pledged as interest payment. Their dream is to see the entire surplus capitalized into debt service to carry loans. Net real estate rent, corporate cash flow (ebitda: earnings before interest, taxes, depreciation and amortization), personal income above basic spending needs, and net government tax revenues can be capitalized into as much as banks will lend. And the more credit they lend, the higher prices are bid up for real estate, stocks and bonds.
So bank lending is applauded for making economies richer, even as families and businesses are loaded down with more and more debt. And the easier debt leveraging becomes, the more asset prices rise. Lower interest rates, lower down payments, more stretched-out amortization periods, and even fraudulent “devil may care” lending thus increase the “capitalization rate” of real estate and business revenue. This is applauded as “wealth creation” – which turns out to be debt-leveraged asset-price inflation and can infect an entire economy.
The limit of this policy is reached when the entire surplus is turned into debt service. At this point the economy is fully financialized. Income spent to pay debts is not available for new investment or consumption spending, so the “real” economy is debt-shackled and must shrink.
The financial takeoff thus ends in a crash. That is what the world is seeing today, at least outside of Brazil and its fellow BRIC countries. For these economies, the question is whether they will follow the same financialization path.
The World Bank and IMF are Not Reformable
A document put out by the Council of Economic Advisors to the President (CDES) speaks of “reforming” the IMF, World Bank and even the United Nations. I don’t believe that this hope is realistic. As I analyzed in Super Imperialism (1972 and 2002), the World Bank and IMF are committed to a basically destructive economic philosophy.
In the case of agricultural development, the World Bank is authorized only to make foreign-currency loans aimed at increasing exports. Its lending accordingly has been for roads and export infrastructure, not to develop the local economy. The effect has been to shift agricultural patterns away from feeding domestic populations with domestic grain crops, to exporting plantation crops. The latter’s global oversupply has lowered Third World terms of trade while enabling the United States and Europe to become major grain exporters.
This trade pattern benefits the industrial grain-exporting core while driving the periphery into food and debt dependency – for which “interdependence” has become a bureaucratic euphemism. I note that this happy-face word – interdependence – appears in the first sentence of this meeting’s brochure. It implies acquiescence in globalization, as if it is desirable in itself as mutually beneficial to all parties. But in today’s world, interdependence implies three modes of dependency: (1) food dependency, (2) military dependency, and (3) debt dependency. The Washington Consensus promoted by the International Monetary Fund (IMF), World Bank and U.S. bilateral aid reinforces these three modes of dependency, bolstering U.S. financial and military hegemony.
The drain of payments to creditors and absentee investors forces countries to balance their budgets by selling off their public domain. Credit rating agencies threaten to downgrade counties that do not “play ball” by giving up their commanding heights on the cheap. Lower bond ratings would make these countries pay much higher interest. This system traps them into letting privatizers extract economic rent.
From about 1950 to 1980, World Bank and commercial bank consortia lent governments money to put these assets in place. Now that these loans are paid off, banks are lending all over again to private buyers of these assets. The new owners erect tollbooths on this hitherto public infrastructure – and “expense” their revenue in the form of tax-deductible interest, underwriting charges, high management fees and other largely fictitious “costs of production.” Globalized accounting orthodoxy enables foreign investors to transfer their receipt of user fees and other economic rent out of the country, tax-free. This drives the host economies further into balance-of-payments deficit, leading to even more sell-offs at even steeper distress-price discounts.
In times past, population provided a military advantage, as well as supplying labor for production. But finance wields dominant control today. The lead nations are willing to see Brazil and other BRIC countries grow and export enough labor-intensive goods and raw materials to pay their growing debts. What rentier interests want is the economic surplus, in the form of debt service (interest, amortization and fees) and monopoly rents in the form of tollbooth charges for the roads and other public infrastructure that is being privatized. They add insult to injury by also demanding that governments refrain from taxing these takings, by permitting interest and other technologically unnecessary charges such as depreciation to be tax-deductible. An illusion of non-profit (and hence, non-taxable) business also is given by going along with the accounting pretense of fictitiously low transfer prices for exports.
Corporate accountants quantify these stratagems with an eye to leaving little net income to be reported and taxed. Under this false map of economic reality, seemingly empirical statistics serve mainly to preserve the deceptive neoliberal economic theory behind them.
To keep their monopoly of money creation, creditor nations demand that governments not use their central banks to do what central banks all over the world originally were founded to do: finance public budget deficits by monetizing them to become the national credit base. The pretense is that it would be inflationary for central banks to finance their government’s budget deficits. But it is no more inflationary than permitting central banks to create credit on their own keyboards!
The European Central Bank insists that governments borrow only from commercial banks and other private-sector creditors – and even that foreign bank branches in host countries can denominate loans in the currency used by the head office or other foreign currencies. Swedish branch banks in Latvia and Austrian bank branches in Hungary thus make loans denominated in Euros. Creditor-nation banks thus can invade and conquer by creating their own local electronic credit, violating the prime directive of wise financial management: never denominate debts in hard foreign currency, when your income is in soft domestic currency.
The demand that countries “balance their budgets” is a euphemism for selling off the public domain and slashing pensions and public spending on education, medical care and other basic preconditions for raising labor productivity. Such austerity demands the opposite of the Keynesian policies followed by the United States itself. Economies subjected to the Washington Consensus fall further and further behind, making the global economy more polarized and unstable. The collapse of the “Baltic Tigers” and other post-Soviet economies where neoliberal planners had a free hand stands as an object lesson for how self-destructive these policies are for nations that submit to them.
What turns out to be ironic is that the tax philosophy favoring debt leveraging rather than equity investment is destroying the creditor core economies as well as the financialized periphery. That is the blowback that Europe and North America are now experiencing. They have let free credit creation subject their own economies to debt deflation – the same dysfunctional policies that impaired Third World development from the 1960s onward!
It is to prevent the resulting shrinkage of the “real” economy – and indeed, debt peonage – that European labor unions are mounting a general strike on September 28, 2010, against austerity plans that would roll back living standards. The move by the BRIC countries to create an alternative financial system and trade and development philosophy for themselves is a kindred reaction against the neo-rentier counter-Enlightenment that is determined to undermine classical economic reform.
The Importance of Economic Ideology to Make a New Beginning
The most important factor in the economic strength of Brazil and its fellow BRIC countries is that you are not yet as debt-ridden as North America and Europe. Your advantages do indeed include your population and natural resources, but you have had these all along. What makes you so attractive to the North is that you are the remnant of the global economy that has not yet buckled under their debt burden. Your economic surplus is not yet pledged to pay debt service, so bankers eye you as not yet “loaned up.”
Your main economic problem is how to protect yourself from the proliferation of credit and debt that has dragged down the North like an invading army, along with the privatization of natural monopolies and financial privileges. Your solution must be to follow an alternative to the regressive financial and tax ideology promoted by today’s international institutions.
What is needed today is not just a “global governance revision” but an outright break from the past. Revision tends to be merely marginal, not the structural change that is called for.
When building a new foundation, it is easier to replace old institutions and start afresh than to try to modify bad institutions and retrain personnel who are committed to entrenched, dysfunctional past policies. An outstanding example of this is U.S. policy after its Civil War. To develop the logic for their economic program, the Republican Party at that time (not today’s neoliberal Republicans!) founded land-grant state colleges and endowed business schools to teach the protectionist and technology-based alternative to the British free trade doctrine being taught at the most prestigious colleges such as Harvard, Yale and Princeton. The result was the doctrine that would propel the United States to world leadership by means of protective tariffs, a national bank and public infrastructure investment.
We have before us four objectives for discussion:
This accounting format rejects the classical definition of economic rent as the excess of market price extracted over and above the necessary costs of production. The result is merely a map of the economy as seen by a predatory bankers’-eye view of the world – a view of how they play only a productive role, as if all credit and debt leveraging were productive rather than extractive.
Obviously, this view fails to reflect today’s economic problem or how industrial economies are being post-industrialized and financialized. “The devil wins at the point where he convinces the world that he does not really exist,” quipped Charles Baudelaire. Providing privatized services, including bank credit, health insurance and other “tollbooth”-type fees at a price in excess of these necessary costs should be treated as transfer payments, not as output.
The GDP accounting format and national balance sheet analysis are asymmetrical in undervaluing land and other natural resources relative to capital and rent imputations. The pretense is that buildings grow in value even while being depreciated. Meanwhile, free market ideology deters governments from calculating the economic cost of recovering the exhaustion of mineral and subsoil wealth and forests from private exploitation. A depletion allowance is given to private investors for making holes in the ground and cutting down forests. It would be more economically fair for them to make payments to reimburse the national economy that is losing this patrimony or suffering environmental cleanup charges.
Free traders have opposed including such calculations for national depletion, cleanup or other restoration charges in national accounts. Taking them into account would reduce the gains-from-trade calculations with which neoliberal trade theory indoctrinates students and public officials. This ideological prejudice makes current practice doctrinaire, not empirical science.
The international economy needs an accounting format to calculate the national ability to pay foreign debts. In 1929 the Young Plan averted global financial breakdown by finally limiting Germany’s reparations payments for World War I in the context of calculating how much foreign exchange Germany could earn (and pay) in the normal course of trade, as distinct from simply borrowing new money or selling off assets. Trying to pay by taking on more debt or selling assets is not to be viewed as a normal ability to carry debt in equilibrium.
In such circumstances the debts should be deemed to have gone bad and be written down. The alternative is the kind of asset stripping that Iceland and Latvia are now suffering, and that Third World countries suffered in the late 1970s and ‘80s. This is the road to debt peonage, shrinking the economy and spurring emigration of the labor force as well as capital flight, benefiting the few at home and abroad.
These shortcomings prevent the GDP format from being a good guide for public policy-making. The two above problems – austerity policy and the current pro-rentier map of the economy – have promoted a bankers’-eye view of the world advocating
In terms of international balance, the cost of labor is inflated by payments owed to the FIRE sector. By contrast, when trade theory was elaborated by British free traders, American protectionists and other economists in the 19th century, it was spending on food and other consumer goods that provided the basis for labor cost comparisons among nations. Today’s U.S. trade deficit, for example stems largely from the fact that homeowners typically pay up to 40 per cent of their income for mortgage debt service and other carrying charges, 15 per cent for other debt (credit card interest and fees, auto loans, student loans, etc.), 11 per cent for FICA wage withholding for Social Security and Medicare, and about 10 to 15 per cent in other taxes (income and excise taxes). So debt-leveraged real estate and consumption are aggravated by forced saving set-asides in the form of “pension fund capitalism” run by money managers. And this brings us to the topic of
Summary
It seems obvious that financial reform is needed – and this requires fiscal reform as well. The fact that whatever the tax collector relinquishes is available (“free”) to be pledged to creditors as interest makes the fiscal problem part and parcel of this financial problem. The economic rent that governments relinquish is “free” to be captured by the banks, which capitalize untaxed revenue into bank loans. This is how economies load themselves down with debt. Lower taxes on rent leave more revenue available to pay interest on loans made to enable borrowers to bid up prices. Meanwhile, cutting taxes on unearned income obliges the government to make up the gap by taxing labor and tangible industrial investment more, raising their supply price, or borrowing from the banks at interest.
Today’s budget deficits thus have gone hand in hand with over-indebted economies, and with a regressive tax shift that burdens productive labor and industry. The tax systems of nearly all countries today favor debt financing – and hence, asset-price inflation – by permitting interest and financial fees to be tax-deductible, while dividends and earnings must be paid after taxes. This un-taxing of land and rent-extracting monopolies goes against the logic of Saint-Simon and other 19th-century reformers who sought to free markets from debt overhead, not to free bankers and financiers from regulation and taxation.
Today’s financialized world is paying a steep price for its rentier-sponsored reaction against classical economics. This reaction distracted attention from the fact that economies suffer a rising “free lunch” of what J. S. Mill called unearned income and unearned increments in the form of higher land rent and land prices. Rent extraction is the business plan of privatizers of public infrastructure and natural monopolies – and of their financial backers seeking to provide buyout loans. The tragedy of our epoch is that most credit is extended to buy rent-extracting opportunities, not for productive capital formation. Banks prefer to lend against property already in place – real estate or companies – than to finance tangible new capital formation. This poses the threat of globalization taking a corrosive form, ending in debt deflation, privatization and a rentier tollbooth economy rather than becoming a system of mutual gain.
The neoliberal motto of Margaret Thatcher, “There is No Alternative” (TINA), ignores the alternative advocated by two hundred years of classical economists. The original liberals – from Adam Smith and the Physiocrats through John Stuart Mill and even Winston Churchill – urged that the tax system be based on the economic rent of land so as to keep down the price of housing (and hence labor’s cost of living). The Progressive Era followed this principle by aiming to keep natural monopolies such as transportation, communication and even banks (or at least, free credit creation) in the public domain. But the post-1980 world has encouraged private owners to buy them on credit and extract economic rent, thereby shifting the tax burden onto labor, industry and agriculture – while concentrating wealth, first on credit and then via the enormous recent public bailouts of this failed financial debt pyramiding and deregulation.
This is what is shrinking the Northern economies today as they suffer from economic polarization between creditors and debtors, property owners and an increasingly insecure labor force – insecure because it is so deeply in debt that losing a job or being fired threatens loss of one’s home and solvency.
Austerity and economic shrinkage are not necessary. There is an alternative. Given the bankers’-eye view of the world promoted by the IMF, World Bank and most mainstream economists, your task must be to stay free of globalization in today’s financialized form. Your counter is simple enough: Do not permit outsiders to buy your assets and drive up your currency’s exchange rate with “computer keyboard” credit that you do not need. Commercial banking requires careful public regulation, with the government itself controlling money-creation, leaving banks to act as intermediaries. The aim of financial regulatory policy should be to make sure that Brazil’s economic surplus is invested in production to raise living standards rather than relinquishing money creation to foreign and domestic financial interests aiming mainly at currency speculation, interest and rent extraction.
You face a danger from mounting global pressure backing policies to slash your living standards, capital investment and infrastructure spending in order to pay exponentially growing private and public debts. Unless debts are written off, or at least reduced to the reasonable ability to pay, economies throughout the world will suffer waves of foreclosure, financial polarization between creditors and debtors, and ultimately social collapse.
At issue is the concept of free markets. Are they to be free from monopoly and special privilege, or free for the occupying financial invaders and speculators? The reform of classical political economy in the 18th and 19th centuries was to keep “free lunch” rent from rising land and raw materials prices, financial credit creation and related monopolies in the public domain.
Looking back on history, we can see how the economies created by the conquerors of Europe and its subsequent colonies were based on war making and looting, seizure of the land, taxation, royal war debts – and, by the 17th century, the creation of Crown monopolies to sell off to raise the money to pay off these debts. (The South Sea and Mississippi Companies in the 1710s are the culminating examples of this practice.) This led to high-cost, debt-ridden economies in Britain and France. It was against such wasteful – and technologically unnecessary – overhead that classical economics was developed as a reform program. The main aim was to make these nations more competitive by freeing their markets from rent and monopolies, and from taxes levied mainly on labor and industry for unproductive spending on wars and empire building. A kindred aim was to reform the financial system to replace debt financing with equity investment. And increasing reform pressure grew for public subsidy of basic infrastructure, especially outside of Britain.
Neoliberals advocate the opposite policy. They define a free market as one that is free for rentiers to extract economic rent and interest. The effect is to turn the public domain into a field of tollbooths for roads and other basic infrastructure charging entry prices and user fees that are loaded with built-in financial charges, exorbitant salaries and rake-offs that raise the economy’s cost of living and doing business.
So we are brought back to how privatizing the public domain and financializing the economy is akin to military defeat. To defend themselves, the BRIC countries need to isolate themselves from global debt creation. The “dialogue” your conference calls for with regard to rules for “new global governance” is unlikely to reach a consensus under today’s conditions where the United States and EU, the World Bank and IMF are urging austerity. They are calling for a sacrifice of labor’s Social Security and pension savings in order to extract payment for the debt overhang that has been allowed to develop.
Debt leveraging and asset-price inflation have been encouraged by the past generation’s fiscal ideology giving tax favoritism for interest and capital gains. This pro-rentier tax favoritism was the opposite of classical free-market reforms and was bound to fail. Yet its sponsors have the audacity to claim Adam Smith, J. S. Mill and their followers as the patron saints of neoliberalism. Classical political economy endorsed a broadening array of public services and social support outside of the market. The United States subsidized its industrial takeoff by realizing that roads, public health and other basic services should be provided freely rather than burdened with intrusive toll charges. Neoliberal ideology asserts that such public investment and regulation is the “road to serfdom” and proposes in its place what may best be thought of as the real road to debt peonage – tax favoritism for debt leverage followed by debt deflation and austerity.
A century ago, even fifty years ago, most of the world was embarking on a program of public infrastructure investment, including central bank or treasury credit for government spending. This was the classical policy program to free economies from the rentier overhead that now is proliferating in much of the world. It is this financial, real estate and monopoly overhead that is pricing Northern Hemisphere labor and industry out of world markets – and leading its investors to look south for more to plunder.
Fortunately, Brazil and its fellow BRIC members have an opportunity to create the classical 19th-century version of free markets, checks and balances that has failed in the North.
By MICHAEL HUDSON
Last Thursday Michael Hudson addressed the Council of Economic Advisors to the President of Brazil (CDES) . He offered an unsparing description of how the global economy is being shaped and exploited by Northern bankers. Then he outlined the ways in which Brazil and other major “BRIC” economies – Russia, Chinas, India – can steer an independent path and thus preserve and improve their nations’ condition . CounterPunch is delighted to feature here Dr Hudson’s very striking address. AC/JSC
Brasilia
Toward what goal is the world economy steering?
That obviously depends on who is doing the steering. It almost always has been the most powerful nations that organize the world in ways that transfer income and property to themselves. From the Roman Empire through modern Europe such transfers took mainly the form of military seizure and tribute. The Norman conquerors endowed themselves as a landed aristocracy extracting rent, as did the Nordic conquerors of France and other countries. Europe later took resources by colonial conquest, increasingly via local client oligarchies.
Today, financial maneuvering and debt leverage play the role that military conquest did in times past. Its aim is still to control land, basic infrastructure and the economic surplus – and also to gain control of national savings, commercial banking and central bank policy. This financial conquest is achieved peacefully and even voluntarily rather than militarily. But the aim is the same: to make subject populations pay – as debtors and as dependent junior trade partners. Indebted “host economies” are in a similar position to that of defeated countries. Their economic surplus is transferred abroad financially, while locally, debtors lose sovereignty over their own financial, economic and tax policy. Public infrastructure is sold off to foreign buyers, on credit and therefore paying interest and fees that are expensed as tax-deductible and paid to foreigners.
The Washington Consensus applauds this pro-rentier policy. Its neoliberal ideology holds that the most efficient path to wealth is to shift economic planning out of the hands of government into those of bankers and money managers in charge of privatizing and financializing the economy. Almost without anyone noticing, this view is replacing the classical law of nations based on the idea of sovereignty over debt and financial policy, tariff and tax policy. Ideology itself has become an economic weapon. Indebted governments have been told since 1980 to sell off their public infrastructure to foreign investors. Extractive “tollbooth” charges (economic rent) replace moderate or subsidized public user fees, making economies less competitive and painting them even more into a debt corner as the surplus is transferred abroad, largely tax-free.
What the world is experiencing in the face of today’s globalism is a crisis in the character of nationhood and economic sovereignty. Bankers in the North look upon any economic surplus – real estate rent, corporate cash flow or even the government’s taxing power or ability to sell off public enterprises – as a source of revenue to pay interest on debts. The result is a more debt-leveraged economy – in all countries. Foreign investment, bank lending, the privatization of public infrastructure and currency speculation is now viewed from this bankers’-eye perspective.
There is one great exception to relinquishing national policy to foreign control: the United States itself is by far the world’s largest debtor economy. While mobilizing creditor power to force other debtors to privatize their public sectors and acquiesce in a one-sided U.S. trade protectionism, the United States is the only nation able to issue its own currency (Treasury debt) and international bank credit without limit, at a lower interest rate than any other country, and even without any foreseeable means to pay.
This double standard has transformed the character of international finance and the meaning of capital inflows. Money no longer is an asset in the form of gold or silver bullion reflecting what has been produced by labor. Money is credit, and hence finds its counterpart in debt on the liabilities side of the balance sheet. Since the United States suspended gold convertibility of the dollar in 1971, international money – the savings of central banks – has taken the form mainly of U.S. Treasury debt, that is, loans to the United States to finance its twin balance-of-payments and budget deficits (both of which are largely military in character). Meanwhile, domestic commercial bank credit takes the form of private debt – mortgage debt, corporate debt (increasingly for debt leveraged takeovers), and even loans for speculation on financial derivatives and currency gambles.
Little bank credit has gone to finance tangible capital investment. Most such investment has been paid for out of retained business earnings, not bank loans. And as banks and brokerage houses have financed corporate takeovers, the new buyers or raiders have had to divert corporate cash flow to paying back their creditors rather than expanding production. This is how the U.S. and other economies have become financialized and post-industrialized. Their experience should serve as an object lesson for what Brazil and other countries need to avoid.
U.S. bank lending has been the major dynamic fueling a global inflation of real estate, stock and bond prices, bolstered over the past decade by European bank lending. Dollar credit (like yen credit after 1990) is created “freely” without the constraint that used to occur when capital outflows forced central banks either to raise national interest rates or lose their gold stocks. In fact, any economy today can create its own domestic credit on its own computer keyboards – those of its central bank and commercial banks. Under today’s conditions, foreign loans do not provide resources that host countries cannot create for themselves. The effect of foreign credit converted into domestic currency is merely to siphon off interest and economic rent.
It is not widely recognized that most commercial bank loans merely attach debt to existing assets (above all, real estate and infrastructure) rather than being invested in creating new means of production, or to employ labor, or even to earn a profit. Banks prefer to lend against assets already in place – real estate, or entire companies. So most bank loans are used to bid up of prices for assets, especially those whose prices are expected to rise by enough to pay the interest on the loan.
The fact that bankers can create interest-bearing debt on computer keyboards with little cost of production poses the question of whether to leave this free lunch (economic rent) in private hands or treat money creation as a public “institutional” good. Classical economists urged that such rent-yielding privileges be regulated to keep prices and incomes in line with necessary costs of production. The surest way to do this was to keep monopolies in the public domain to provide basic services at minimum cost or for free while land taxes and user fees could serve as the main source of public revenue. This principle has been flagrantly violated by the practice of erecting privatized “tollbooths” that extract rent revenue without a corresponding cost of production. This has been done in a way that benefits only a select few.
The unchecked explosion of global credit and debt – and hence, pressure to sell off natural monopolies in the public domain – is largely a result of the credit explosion unleashed after gold convertibility ended in 1971. The ensuing U.S. Treasury-bill standard left foreign central banks with no vehicle in which to hold their international reserves except loans to the U.S. Treasury. This gives the U.S. balance-of-payments deficit a free ride, which translates into a military free ride. After the Korean War forced the dollar into deficit status in 1951, overseas military spending throughout the 1950s and ‘60s equaled the entire U.S. payments deficit. The private sector was almost exactly in balance during these decades, while U.S. “foreign aid” actually generated a balance-of-payments surplus, as a result of aid tied to U.S. exports rather than to the needs of aid-recipient countries.
While other countries running trade and payments deficits must increase their interest rates to stabilize their currencies, the United States has lowered its interest rates. This has increased the “capitalization rate” of its real estate rents and corporate earnings, enabling banks to lend more against higher-priced collateral. Property is worth whatever banks will lend against it, so the U.S. economy has been able to use the dollar standard’s free ride to load itself down with an unprecedented debt overhead – an overhead that traditionally has been suffered only by countries fighting wars abroad or burdened with reparations payments. This is the Treasury-bill standard’s self-destructive blowback.
It is an object lesson for Brazil to avoid. Your nation today is receiving balance-of-payments inflows as foreign banks and investors create credit to lend against your real estate, natural resources and industry. Their aim is to obtain your economic surplus in the form of interest payments and remitted earnings, turning you into a rentier tollbooth economy.
Why would you need these “capital inflows” that extract interest, rents and profits as a return for electronic “keyboard credit” that you can create yourself? In today’s world, no nation needs credit from abroad for domestic-currency spending at home. Brazil should avoid letting foreign creditors capitalize its economic surplus into debt service and other payments.
The way to avoid this fate was outlined from the French Physiocrats and Adam Smith through John Stuart Mill and Progressive Era reformers: by ending the special privileges bequeathed by Europe’s military conquests (privatization of land rent), and by collecting “free lunch” rentier income as the tax base to save it from being privatized and capitalized into bank loans. Taxing land and resource rent lowers the cost of living and doing business not only by removing the tax burden on labor and industry, but by holding down housing and real estate prices, because whatever the tax collector relinquishes is available to be pledged to carry bank loans to bid up property prices.
In the 19th century the American System of political economy was based on the perception that highly paid labor is more productive labor, such that well-educated, well-fed and well-clothed labor undersells “pauper” labor. The key to international competitiveness is thus to raise wages and living standards, not lower them. This is especially the case for Brazil, given its need to raise labor productivity by better education, health and social support systems if it is to thrive in the 21st century. And if it is to raise capital investment and living standards free of debt service and higher housing prices, it needs to prevent the economy’s surplus from being turned into a “free lunch” in the form of land rent, resource rent and monopoly rent – and to save this economic surplus from bankers seeking to capitalize it into debt payments. This is best achieved by taxing away the potential rentier charges that turn the surplus into unnecessary overhead.
But because the wealth of nations is now calculated from the banker’s perspective, surplus income is viewed as potentially available to capitalize into debt service. Rather than using the surplus to invest in capital formation and public infrastructure, the distinguishing characteristic of our time is financialization – the capitalization of the economic surplus (corporate cash flow, real estate rent and other economic rent, and personal income over and above basic living costs) into interest payments for bank loans.
This is the business plan of bank marketing departments and is a far cry from what Adam Smith wrote about in The Wealth of Nations. Loan officers see any net flow of income as potentially available to be pledged as interest payment. Their dream is to see the entire surplus capitalized into debt service to carry loans. Net real estate rent, corporate cash flow (ebitda: earnings before interest, taxes, depreciation and amortization), personal income above basic spending needs, and net government tax revenues can be capitalized into as much as banks will lend. And the more credit they lend, the higher prices are bid up for real estate, stocks and bonds.
So bank lending is applauded for making economies richer, even as families and businesses are loaded down with more and more debt. And the easier debt leveraging becomes, the more asset prices rise. Lower interest rates, lower down payments, more stretched-out amortization periods, and even fraudulent “devil may care” lending thus increase the “capitalization rate” of real estate and business revenue. This is applauded as “wealth creation” – which turns out to be debt-leveraged asset-price inflation and can infect an entire economy.
The limit of this policy is reached when the entire surplus is turned into debt service. At this point the economy is fully financialized. Income spent to pay debts is not available for new investment or consumption spending, so the “real” economy is debt-shackled and must shrink.
The financial takeoff thus ends in a crash. That is what the world is seeing today, at least outside of Brazil and its fellow BRIC countries. For these economies, the question is whether they will follow the same financialization path.
The World Bank and IMF are Not Reformable
A document put out by the Council of Economic Advisors to the President (CDES) speaks of “reforming” the IMF, World Bank and even the United Nations. I don’t believe that this hope is realistic. As I analyzed in Super Imperialism (1972 and 2002), the World Bank and IMF are committed to a basically destructive economic philosophy.
In the case of agricultural development, the World Bank is authorized only to make foreign-currency loans aimed at increasing exports. Its lending accordingly has been for roads and export infrastructure, not to develop the local economy. The effect has been to shift agricultural patterns away from feeding domestic populations with domestic grain crops, to exporting plantation crops. The latter’s global oversupply has lowered Third World terms of trade while enabling the United States and Europe to become major grain exporters.
This trade pattern benefits the industrial grain-exporting core while driving the periphery into food and debt dependency – for which “interdependence” has become a bureaucratic euphemism. I note that this happy-face word – interdependence – appears in the first sentence of this meeting’s brochure. It implies acquiescence in globalization, as if it is desirable in itself as mutually beneficial to all parties. But in today’s world, interdependence implies three modes of dependency: (1) food dependency, (2) military dependency, and (3) debt dependency. The Washington Consensus promoted by the International Monetary Fund (IMF), World Bank and U.S. bilateral aid reinforces these three modes of dependency, bolstering U.S. financial and military hegemony.
The drain of payments to creditors and absentee investors forces countries to balance their budgets by selling off their public domain. Credit rating agencies threaten to downgrade counties that do not “play ball” by giving up their commanding heights on the cheap. Lower bond ratings would make these countries pay much higher interest. This system traps them into letting privatizers extract economic rent.
From about 1950 to 1980, World Bank and commercial bank consortia lent governments money to put these assets in place. Now that these loans are paid off, banks are lending all over again to private buyers of these assets. The new owners erect tollbooths on this hitherto public infrastructure – and “expense” their revenue in the form of tax-deductible interest, underwriting charges, high management fees and other largely fictitious “costs of production.” Globalized accounting orthodoxy enables foreign investors to transfer their receipt of user fees and other economic rent out of the country, tax-free. This drives the host economies further into balance-of-payments deficit, leading to even more sell-offs at even steeper distress-price discounts.
In times past, population provided a military advantage, as well as supplying labor for production. But finance wields dominant control today. The lead nations are willing to see Brazil and other BRIC countries grow and export enough labor-intensive goods and raw materials to pay their growing debts. What rentier interests want is the economic surplus, in the form of debt service (interest, amortization and fees) and monopoly rents in the form of tollbooth charges for the roads and other public infrastructure that is being privatized. They add insult to injury by also demanding that governments refrain from taxing these takings, by permitting interest and other technologically unnecessary charges such as depreciation to be tax-deductible. An illusion of non-profit (and hence, non-taxable) business also is given by going along with the accounting pretense of fictitiously low transfer prices for exports.
Corporate accountants quantify these stratagems with an eye to leaving little net income to be reported and taxed. Under this false map of economic reality, seemingly empirical statistics serve mainly to preserve the deceptive neoliberal economic theory behind them.
To keep their monopoly of money creation, creditor nations demand that governments not use their central banks to do what central banks all over the world originally were founded to do: finance public budget deficits by monetizing them to become the national credit base. The pretense is that it would be inflationary for central banks to finance their government’s budget deficits. But it is no more inflationary than permitting central banks to create credit on their own keyboards!
The European Central Bank insists that governments borrow only from commercial banks and other private-sector creditors – and even that foreign bank branches in host countries can denominate loans in the currency used by the head office or other foreign currencies. Swedish branch banks in Latvia and Austrian bank branches in Hungary thus make loans denominated in Euros. Creditor-nation banks thus can invade and conquer by creating their own local electronic credit, violating the prime directive of wise financial management: never denominate debts in hard foreign currency, when your income is in soft domestic currency.
The demand that countries “balance their budgets” is a euphemism for selling off the public domain and slashing pensions and public spending on education, medical care and other basic preconditions for raising labor productivity. Such austerity demands the opposite of the Keynesian policies followed by the United States itself. Economies subjected to the Washington Consensus fall further and further behind, making the global economy more polarized and unstable. The collapse of the “Baltic Tigers” and other post-Soviet economies where neoliberal planners had a free hand stands as an object lesson for how self-destructive these policies are for nations that submit to them.
What turns out to be ironic is that the tax philosophy favoring debt leveraging rather than equity investment is destroying the creditor core economies as well as the financialized periphery. That is the blowback that Europe and North America are now experiencing. They have let free credit creation subject their own economies to debt deflation – the same dysfunctional policies that impaired Third World development from the 1960s onward!
It is to prevent the resulting shrinkage of the “real” economy – and indeed, debt peonage – that European labor unions are mounting a general strike on September 28, 2010, against austerity plans that would roll back living standards. The move by the BRIC countries to create an alternative financial system and trade and development philosophy for themselves is a kindred reaction against the neo-rentier counter-Enlightenment that is determined to undermine classical economic reform.
The Importance of Economic Ideology to Make a New Beginning
The most important factor in the economic strength of Brazil and its fellow BRIC countries is that you are not yet as debt-ridden as North America and Europe. Your advantages do indeed include your population and natural resources, but you have had these all along. What makes you so attractive to the North is that you are the remnant of the global economy that has not yet buckled under their debt burden. Your economic surplus is not yet pledged to pay debt service, so bankers eye you as not yet “loaned up.”
Your main economic problem is how to protect yourself from the proliferation of credit and debt that has dragged down the North like an invading army, along with the privatization of natural monopolies and financial privileges. Your solution must be to follow an alternative to the regressive financial and tax ideology promoted by today’s international institutions.
What is needed today is not just a “global governance revision” but an outright break from the past. Revision tends to be merely marginal, not the structural change that is called for.
When building a new foundation, it is easier to replace old institutions and start afresh than to try to modify bad institutions and retrain personnel who are committed to entrenched, dysfunctional past policies. An outstanding example of this is U.S. policy after its Civil War. To develop the logic for their economic program, the Republican Party at that time (not today’s neoliberal Republicans!) founded land-grant state colleges and endowed business schools to teach the protectionist and technology-based alternative to the British free trade doctrine being taught at the most prestigious colleges such as Harvard, Yale and Princeton. The result was the doctrine that would propel the United States to world leadership by means of protective tariffs, a national bank and public infrastructure investment.
We have before us four objectives for discussion:
(1) Globalization and labor markets under today’s push for austerity. Under the euphemism of “balanced budgets,” fiscal austerity aims to prevent countries from using their economic surplus to raise living standards. This policy is self-destructive. Austerity prevents productivity from being raised, stifling domestic markets by “freeing” government revenue for paying debt service, bailouts and other transfer payments or subsidies to the finance, insurance and real estate (FIRE) sector at home and abroad.
(2) New development indicators are indeed needed to replace the GDP accounting format with a better map of the economy. Accounting categories reflect economic theory. Classical doctrine divided economies into two parts: (A) the production-and-consumption sector that textbooks usually refer to as the “real” economy, and (B) the extractive FIRE sector (finance, insurance and real estate), which today’s mainstream analysis and GDP accounts define as producing “output” equal in value to what FIRE rentiers charge. So what used to be viewed as overhead is now treated as output, as if it were a necessary part of economic activity.
This accounting format rejects the classical definition of economic rent as the excess of market price extracted over and above the necessary costs of production. The result is merely a map of the economy as seen by a predatory bankers’-eye view of the world – a view of how they play only a productive role, as if all credit and debt leveraging were productive rather than extractive.
Obviously, this view fails to reflect today’s economic problem or how industrial economies are being post-industrialized and financialized. “The devil wins at the point where he convinces the world that he does not really exist,” quipped Charles Baudelaire. Providing privatized services, including bank credit, health insurance and other “tollbooth”-type fees at a price in excess of these necessary costs should be treated as transfer payments, not as output.
The GDP accounting format and national balance sheet analysis are asymmetrical in undervaluing land and other natural resources relative to capital and rent imputations. The pretense is that buildings grow in value even while being depreciated. Meanwhile, free market ideology deters governments from calculating the economic cost of recovering the exhaustion of mineral and subsoil wealth and forests from private exploitation. A depletion allowance is given to private investors for making holes in the ground and cutting down forests. It would be more economically fair for them to make payments to reimburse the national economy that is losing this patrimony or suffering environmental cleanup charges.
Free traders have opposed including such calculations for national depletion, cleanup or other restoration charges in national accounts. Taking them into account would reduce the gains-from-trade calculations with which neoliberal trade theory indoctrinates students and public officials. This ideological prejudice makes current practice doctrinaire, not empirical science.
The international economy needs an accounting format to calculate the national ability to pay foreign debts. In 1929 the Young Plan averted global financial breakdown by finally limiting Germany’s reparations payments for World War I in the context of calculating how much foreign exchange Germany could earn (and pay) in the normal course of trade, as distinct from simply borrowing new money or selling off assets. Trying to pay by taking on more debt or selling assets is not to be viewed as a normal ability to carry debt in equilibrium.
In such circumstances the debts should be deemed to have gone bad and be written down. The alternative is the kind of asset stripping that Iceland and Latvia are now suffering, and that Third World countries suffered in the late 1970s and ‘80s. This is the road to debt peonage, shrinking the economy and spurring emigration of the labor force as well as capital flight, benefiting the few at home and abroad.
These shortcomings prevent the GDP format from being a good guide for public policy-making. The two above problems – austerity policy and the current pro-rentier map of the economy – have promoted a bankers’-eye view of the world advocating
(3) An unsustainable development policy. Debts growing at exponential rates (“the magic of compound interest”) are not sustainable. Trying to pay them makes economies less competitive and impoverishes populations, leading to defaults both in domestic and foreign currency, and hence to social unrest.
In terms of international balance, the cost of labor is inflated by payments owed to the FIRE sector. By contrast, when trade theory was elaborated by British free traders, American protectionists and other economists in the 19th century, it was spending on food and other consumer goods that provided the basis for labor cost comparisons among nations. Today’s U.S. trade deficit, for example stems largely from the fact that homeowners typically pay up to 40 per cent of their income for mortgage debt service and other carrying charges, 15 per cent for other debt (credit card interest and fees, auto loans, student loans, etc.), 11 per cent for FICA wage withholding for Social Security and Medicare, and about 10 to 15 per cent in other taxes (income and excise taxes). So debt-leveraged real estate and consumption are aggravated by forced saving set-asides in the form of “pension fund capitalism” run by money managers. And this brings us to the topic of
(4) Global governance. Who shall set the rules? And in whose interest are they to be set? When discussing austerity in (1) above, we need to ask, “austerity for whom?” Will mortgages and other debts be written down to the ability to pay? If they are, banks and the wealthiest 10 per cent of the population will have to lose some of the financial advantage that enable them to reduce the bottom 90 per cent to a state of debt peonage. But if debts are not written down, the result will be debt deflation that can destroy entire economies. Homeowners and businesses have to use their income to pay their bankers, not spend on goods and services. So employment and national output will continue to shrink. The corrosive role of debt is the major choice facing countries today, and hence the focus of rival plans for global governance.
Summary
It seems obvious that financial reform is needed – and this requires fiscal reform as well. The fact that whatever the tax collector relinquishes is available (“free”) to be pledged to creditors as interest makes the fiscal problem part and parcel of this financial problem. The economic rent that governments relinquish is “free” to be captured by the banks, which capitalize untaxed revenue into bank loans. This is how economies load themselves down with debt. Lower taxes on rent leave more revenue available to pay interest on loans made to enable borrowers to bid up prices. Meanwhile, cutting taxes on unearned income obliges the government to make up the gap by taxing labor and tangible industrial investment more, raising their supply price, or borrowing from the banks at interest.
Today’s budget deficits thus have gone hand in hand with over-indebted economies, and with a regressive tax shift that burdens productive labor and industry. The tax systems of nearly all countries today favor debt financing – and hence, asset-price inflation – by permitting interest and financial fees to be tax-deductible, while dividends and earnings must be paid after taxes. This un-taxing of land and rent-extracting monopolies goes against the logic of Saint-Simon and other 19th-century reformers who sought to free markets from debt overhead, not to free bankers and financiers from regulation and taxation.
Today’s financialized world is paying a steep price for its rentier-sponsored reaction against classical economics. This reaction distracted attention from the fact that economies suffer a rising “free lunch” of what J. S. Mill called unearned income and unearned increments in the form of higher land rent and land prices. Rent extraction is the business plan of privatizers of public infrastructure and natural monopolies – and of their financial backers seeking to provide buyout loans. The tragedy of our epoch is that most credit is extended to buy rent-extracting opportunities, not for productive capital formation. Banks prefer to lend against property already in place – real estate or companies – than to finance tangible new capital formation. This poses the threat of globalization taking a corrosive form, ending in debt deflation, privatization and a rentier tollbooth economy rather than becoming a system of mutual gain.
The neoliberal motto of Margaret Thatcher, “There is No Alternative” (TINA), ignores the alternative advocated by two hundred years of classical economists. The original liberals – from Adam Smith and the Physiocrats through John Stuart Mill and even Winston Churchill – urged that the tax system be based on the economic rent of land so as to keep down the price of housing (and hence labor’s cost of living). The Progressive Era followed this principle by aiming to keep natural monopolies such as transportation, communication and even banks (or at least, free credit creation) in the public domain. But the post-1980 world has encouraged private owners to buy them on credit and extract economic rent, thereby shifting the tax burden onto labor, industry and agriculture – while concentrating wealth, first on credit and then via the enormous recent public bailouts of this failed financial debt pyramiding and deregulation.
This is what is shrinking the Northern economies today as they suffer from economic polarization between creditors and debtors, property owners and an increasingly insecure labor force – insecure because it is so deeply in debt that losing a job or being fired threatens loss of one’s home and solvency.
Austerity and economic shrinkage are not necessary. There is an alternative. Given the bankers’-eye view of the world promoted by the IMF, World Bank and most mainstream economists, your task must be to stay free of globalization in today’s financialized form. Your counter is simple enough: Do not permit outsiders to buy your assets and drive up your currency’s exchange rate with “computer keyboard” credit that you do not need. Commercial banking requires careful public regulation, with the government itself controlling money-creation, leaving banks to act as intermediaries. The aim of financial regulatory policy should be to make sure that Brazil’s economic surplus is invested in production to raise living standards rather than relinquishing money creation to foreign and domestic financial interests aiming mainly at currency speculation, interest and rent extraction.
You face a danger from mounting global pressure backing policies to slash your living standards, capital investment and infrastructure spending in order to pay exponentially growing private and public debts. Unless debts are written off, or at least reduced to the reasonable ability to pay, economies throughout the world will suffer waves of foreclosure, financial polarization between creditors and debtors, and ultimately social collapse.
At issue is the concept of free markets. Are they to be free from monopoly and special privilege, or free for the occupying financial invaders and speculators? The reform of classical political economy in the 18th and 19th centuries was to keep “free lunch” rent from rising land and raw materials prices, financial credit creation and related monopolies in the public domain.
Looking back on history, we can see how the economies created by the conquerors of Europe and its subsequent colonies were based on war making and looting, seizure of the land, taxation, royal war debts – and, by the 17th century, the creation of Crown monopolies to sell off to raise the money to pay off these debts. (The South Sea and Mississippi Companies in the 1710s are the culminating examples of this practice.) This led to high-cost, debt-ridden economies in Britain and France. It was against such wasteful – and technologically unnecessary – overhead that classical economics was developed as a reform program. The main aim was to make these nations more competitive by freeing their markets from rent and monopolies, and from taxes levied mainly on labor and industry for unproductive spending on wars and empire building. A kindred aim was to reform the financial system to replace debt financing with equity investment. And increasing reform pressure grew for public subsidy of basic infrastructure, especially outside of Britain.
Neoliberals advocate the opposite policy. They define a free market as one that is free for rentiers to extract economic rent and interest. The effect is to turn the public domain into a field of tollbooths for roads and other basic infrastructure charging entry prices and user fees that are loaded with built-in financial charges, exorbitant salaries and rake-offs that raise the economy’s cost of living and doing business.
So we are brought back to how privatizing the public domain and financializing the economy is akin to military defeat. To defend themselves, the BRIC countries need to isolate themselves from global debt creation. The “dialogue” your conference calls for with regard to rules for “new global governance” is unlikely to reach a consensus under today’s conditions where the United States and EU, the World Bank and IMF are urging austerity. They are calling for a sacrifice of labor’s Social Security and pension savings in order to extract payment for the debt overhang that has been allowed to develop.
Debt leveraging and asset-price inflation have been encouraged by the past generation’s fiscal ideology giving tax favoritism for interest and capital gains. This pro-rentier tax favoritism was the opposite of classical free-market reforms and was bound to fail. Yet its sponsors have the audacity to claim Adam Smith, J. S. Mill and their followers as the patron saints of neoliberalism. Classical political economy endorsed a broadening array of public services and social support outside of the market. The United States subsidized its industrial takeoff by realizing that roads, public health and other basic services should be provided freely rather than burdened with intrusive toll charges. Neoliberal ideology asserts that such public investment and regulation is the “road to serfdom” and proposes in its place what may best be thought of as the real road to debt peonage – tax favoritism for debt leverage followed by debt deflation and austerity.
A century ago, even fifty years ago, most of the world was embarking on a program of public infrastructure investment, including central bank or treasury credit for government spending. This was the classical policy program to free economies from the rentier overhead that now is proliferating in much of the world. It is this financial, real estate and monopoly overhead that is pricing Northern Hemisphere labor and industry out of world markets – and leading its investors to look south for more to plunder.
Fortunately, Brazil and its fellow BRIC members have an opportunity to create the classical 19th-century version of free markets, checks and balances that has failed in the North.
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