by Michael Hudson, New Economic Perspectives
Remarks by Prof. Michael Hudson at The Atlantic’s Economy Summit, Washington DC, Wednesday, March 13, 2013.
There are two quite different perspectives in the set of speeches at this conference. Many on our morning panels – Steve Keen, William Greider, and earlier Yves Smith and Robert Kuttner – have warned about the economy being strapped by debt. The debt we are talking about is private-sector debt. But most officials this afternoon focus on government debt and budget deficits as the problem – especially social spending such as Social Security, not bailouts to the banks and Federal Reserve credit to re-inflate prices for real estate, stocks and bonds.
To us this morning, government deficit spending into the economy is the solution. The problem is private debt. And in contrast to Federal Reserve and Treasury bailout policy, we view the problem not as real estate prices too low to cover bank reserves. The problem is the carrying charges on this private debt, and the fact that debt service is eating into personal income – and also business income – to deflate the economy.
Mortgage debt that is still leading to foreclosures, evictions, and is depressing the real estate market for most buyers except for all-cash hedge funds;
We have been urging a write-down of mortgage debt in line with the debtor’s ability to pay, or to bring debt service in line with current market prices. The administration has bailed out the banks for their bad loans, but has kept the debts in place for most of the population. Its promise of debt write-downs has been empty.
Student loan debt, now the second largest debt in the US at around $1 trillion, is the one kind of debt that has been growing since 2008. It is depriving new graduates of the ability to start families and buy new homes. This debt is partly a byproduct of cutbacks in federal and local aid to the universities, and partly of turning them into profit centers – financializing education to squeeze out an economic surplus to invest in real estate and financial holdings, to pay much higher salaries to upper management (but not to professors, who are being replaced by part-time, un-tenured help), and especially to create a thriving high-profit, zero-risk, government guaranteed loan business for banks.
This is not really “socializing” student loans. Its social effects are regressive and negative. It is a bank-friendly giveaway that is helping polarize the economy.
The character of the stock market has been turned upside down. Instead of raising equity capital to reduce corporate debt ratios, corporate takeovers are being financed with debt.
Business debt service is still crowding out the use of corporate cash flow for new tangible investment and hiring. This is especially the case for companies bought in leveraged buyouts for corporate or management takeovers. Shareholder activism is forcing industrial companies to yield financial returns, such as using earnings for stock buy-backs to bid up stock market prices (and thereby increase the value of management stock options). We thus are seeing a buildup of financial capital, not of industrial capital.
The result of the private-sector debt overhang is a self-feeding spiral of debt deflation. Revenue earmarked to pay bankers is not available to spend on goods and services. Lower consumer spending is a major reason why firms are not investing in tangible capital to produce more output. Markets shrink, shopping malls close down, and empty stores are appearing for rent on major shopping streets from New York City to London.
Slowing employment is causing a state and local budget squeeze. Something has to give – and it is largely pension plans, infrastructure spending and social programs.
However, the one kind of debt we are not worried about is government debt. That’s because governments have little problem paying it. They do not need to balance their budget with tax revenue, because their central bank can simply print the money. On balance, the overall public debt rarely needs to be paid down. As Adam Smith noted in The Wealth of Nations, no government in history ever has paid off its public debt.
Today, governments do not even have to pay interest on money their central banks create. (Think of the Civil War greenbacks.) Even for borrowing from bondholders, Treasury borrowing costs are now the lowest in history. As for the monetary effect of governments running budget deficits, there is little threat of commodity-price inflation. Price rises are concentrated where special interests are able to indulge in monopoly pricing and rent extraction.
Yet most of the speeches you will hear this afternoon will warn about the rising government debt, not private-sector debt. The press follows this hand wringing, urging governments to balance the budget to restore “fiscal responsibility.”
The problem is that “fiscal responsibility” is economically irresponsible, as far as full employment and economic recovery are concerned. less government spending shrinks the circular flow between the private sector’s producers and consumers. That is the essence of Modern Monetary Theory (MMT) that Steve Keen here, and Yves Smith in the earlier panel, have been writing about in our blogs.
So I needn’t elaborate here on how the United States should look at Greece, Spain and other eurozone disaster areas that lack a central bank to monetize deficit spending into the economy to restore growth. “Fiscal responsibility” and “smart investment policy” are mutually exclusive. What really is responsible is for the government to spend enough money into the economy to keep employment and production thriving.
Instead, the government is creating new debt mainly to bail out the banks and keep the existing debt overhead in place – instead of writing down the debts.
So governments from the United States to Europe face a choice: to save the economy, or to save the banks and bondholders from taking a loss by keeping the debt overhead in place and re-inflating real estate prices to a level high enough to cover the debts attached to the property whose underwater mortgages are weighing down the banking system.
The problem is that rising housing prices increase the cost of living, and hence of employing labor. When I started to work on Wall Street fifty years ago, banks had a basic rule in lending mortgage money: mortgage debt service should not exceed 25% of family income. A year ago Sheila Bair recommended limiting mortgage lending to 32% of income. Washington’s most recent rules for providing housing loan guarantees raised the ratio to 43%.
When it comes to analyzing comparative advantage among nations, the key no longer is food or prices for other goods and services. Financial charges and taxes are the key. The typical blue-collar family budget provides the explanation for why the United States is losing its industrial advantage.
Only 20 to 25% of the family’s budget is free to buy the commodities being produced. This means that Say’s Law – the circular flow of income and spending between employers and their work force – is diverted to pay debt service, and also to pay including Social Security and Medicare taxes as a user fee instead of these services being paid for out of the general fiscal budget by progressive taxation falling mainly on what Adam Smith, John Stuart Mill and their Progressive Era followers urged: land rent, natural resource rent, monopoly rent, and luxuries.
A Keynesian economist would point to excess saving as the problem. But debt repayment has changed the character of saving in today’s debt-ridden economies. In the 1930s, Keynes pointed to savings being a leakage from the economy’s circular flow. What he meant by “saving” was mainly non-spending – keeping income in bank accounts or other liquid or illiquid financial investment.
But savings rates have risen since 2008 for quite a different reason. America’s recovery of savings rate from zero in 2007 is not a result of people building up saving for a rainy day. What the National Income and Product accounts report as “saving” is actually paying down debt. It is a negation of a negation.
This is what debt deflation means. The antidote should be more government spending and larger deficits – as well as debt forgiveness.
Bank lobbyists are urging just the opposite set of policies. They have implanted a false memory and a false economic theory blaming hyperinflation on deficit spending. The reality is that every hyperinflation in history has come from paying foreign debts, not domestic debts.
Germany’s Weimar inflation resulted from the Reichsbank having to pay reparations to the Allied Powers. It sold German currency on the foreign exchange markets for sterling, francs and dollars – far beyond Germany’s ability to obtain foreign exchange by exporting. Germany had been stripped of its coal and steel production capacity and its ability to export was limited. So the currency plunged.
Declining exchange rates caused import prices to rise. The general price level followed suit behind the umbrella effect of higher import prices. More money had to be printed to pay for transactions purposes at the higher price level. Every serious study of the German hyperinflation – and also those of France and, later, of Chile – shows the same sequence of causation from foreign debt payment to currency depreciation, rising domestic prices, and finally to new money creation.
The German economy suffered from austerity imposed by over-indebtedness. The same was true of debt-strapped Third World economies from the 1960s onward under IMF austerity programs, and it is true of Eurozone countries today. Austerity and lower government spending did not make these economies more competitive. It worsened their balance of payments, and made their distribution of wealth and income more unequal as economies polarized between creditors and debtors.
The policy lesson for today is that to avoid debt deflation, falling markets and unemployment, the economy needs to be revived. The way to do this is what was called for and indeed promised four years ago: a write-down of debts in keeping with the ability to pay.
Once this debt overhead is addressed, tax reform is needed to prevent a debt bubble from recurring. A tax system that favors debt financing rather than equity, and that favors asset-price “capital” gains and windfall gains over wages and industrial profits earned by producing tangible output, has been largely to blame. Also needing reform is tax favoritism for the offshore fictitious accounting that has become increasingly unrealistic in recent years.
Unless government fiscal policy addresses these issues, the U.S. economy will face the same kind of debt-deflation pressures and fiscal austerity that is now tearing the eurozone apart.
There is something striking about the arrangement of talks for later this afternoon. In contrast to the majority on this panel (Steve Keen and William Greider), we saw the crisis coming and warned publicly about it. Steve’s printed bio for this conference gives the Financial Times article that acknowledged this and reproduced my flow chart of the economy. Second, on that flow chart, you will see that for every half a trillion in federal deficit spending since the 2008 crisis, the Federal Reserve and Treasury have spent twice as much – $1 trillion – in providing new credit to the banks.
President Obama announced that he hoped the banks would lend it out. So the solution by his advisors, including some here today, is for the economy to “borrow its way out of debt.” The aim of the Fed and Treasury subsidies of the commercial banks is to re-inflate housing prices, stock and bond prices – on credit. That means on debt.
This obviously will make matters worse. But what will make them worse of all is the demand that the government “cure” the public-sector deficit by spending less generally, and specifically by cutting Social Security and Medicare. As in the case of the recent FICA withholding ostensibly to fund Social Security, the effect of less public spending into the economy is to force the private sector more deeply into debt.
I find there to be something hypocritical about this. Instead of writing down debts of the 99% to keep their financial heads above water, the government is trying to save the banks and the 1% – at public expense. Why do they call for governments to balance the budget by pushing the economy at large deeper into debt, while trying to save the banks from taking a loss?
The ultimate question to be posed is thus whether the economy really needs Wall Street and the banks to be made whole on credit that has been created largely to inflate asset prices (the Bubble Economy) and to gamble on derivatives and computer programs (Casino Capitalism), without really interfacing with the industrial sector and employment – except to provide takeover credit for leveraged buyouts that load down companies further with debt?
Placed in this context, the financial problem thus turns into a structural social problem.
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