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I did not set out to be an economist. In college
at the University of Chicago I never took a course in economics or went
anywhere near its business school. My interest lay in music and the history of
culture. When I left for New York City in 1961, it was to work in publishing
along these lines. I had worked served as an assistant to Jerry Kaplan at the
Free Press in Chicago, and thought of setting out on my own when the Hungarian
literary critic George Lukacs assigned me the English-language rights to his
writings. Then, in 1962 when Leon Trotsky’s widow, Natalia Sedova died, Max
Shachtman, executor of her estate, assigned me the rights to Trotsky’s writings
and archive. But I was unable to interest any house in backing their
publication. My future turned out not to lie in publishing other peoples’ work.
My life already had changed abruptly in a single
evening. My best friend from Chicago had urged that I look up Terence McCarthy,
the father of one of his schoolmates. Terence was a former economist for
General Electric and also the author of the “Forgash Plan.” Named for Florida
Senator Morris Forgash, it proposed a World Bank for Economic Acceleration with
an alternative policy to the existing World Bank – lending in domestic currency
for land reform and greater self-sufficiency in food instead of plantation
export crops.
My first evening’s visit with him transfixed me
with two ideas that have become my life’s work. First was his almost poetic
description of the flow of funds through the economic system. He explained why
most financial crises historically occurred in the autumn when the crops were
moved. Shifts in the Midwestern water level or climatic disruptions in other
countries caused periodic droughts, which led to crop failures and drains on
the banking system, forcing banks to call in their loans. Finance, natural resources
and industry were parts of an interconnected system much like astronomy – and
to me, an aesthetic thing of beauty. But unlike astronomical cycles, the
mathematics of compound interest leads economies inevitably into a debt crash,
because the financial system expands faster than the underlying economy,
overburdening it with debt so that crises grow increasingly severe. Economies
are torn apart by breaks in the chain of payments.
That very evening I decided to become an
economist. Soon I enrolled in graduate study and sought work on Wall Street,
which was the only practical way to see how economies really functioned. For
the next twenty years, Terence and I spoke about an hour a day on current
economic events. He had translated A History of Economic Doctrines: From
the Physiocrats to Adam Smith, the first English-language version of
Marx’s Theories of Surplus Value – which itself was the first real
history of economic thought. For starters, he told me to read all the books in
its bibliography – the Physiocrats, John Locke, Adam Smith, David Ricardo,
Thomas Malthus, John Stuart Mill and so forth.
The topics that most interested me – and the
focus of this book – were not taught at New York University where I took my
graduate economics degrees. In fact, they are not taught in any university
departments: the dynamics of debt, and how the pattern of bank lending inflates
land prices, or national income accounting and the rising share absorbed by
rent extraction in the Finance, Insurance and Real Estate (FIRE) sector. There
was only one way to learn how to analyze these topics: to work for banks. Back
in the 1960s there was barely a hint that these trends would become a great
financial bubble. But the dynamics were there, and I was fortunate enough to be
hired to chart them.
My first job was as mundane as could be
imagined: an economist for the Savings Banks Trust Company. No longer existing,
it had been created by New York’s then-127 savings banks (now also extinct,
having been grabbed, privatized and emptied out by commercial bankers). I was
hired to write up how savings accrued interest and were recycled into new
mortgage loans. My graphs of this savings upsweep looked like Hokusai’s “Wave,”
but with a pulse spiking like a cardiogram every three months on the day
quarterly dividends were credited.
The rise in savings was lent to homebuyers,
helping fuel the post-World War II price rise for housing. This was viewed as a
seemingly endless engine of prosperity endowing a middle class with rising net
worth. The more banks lend, the higher prices rise for the real estate being
bought on credit. And the more prices rise, the more banks are willing to lend
– as long as more people keep joining what looks like a perpetual motion
wealthcreating machine.
The process works only as long as incomes are
rising. Few people notice that most of their rising income is being paid for
housing. They feel that they are saving – and getting richer by paying for an
investment that will grow. At least, that is what worked for sixty years after
World War II ended in 1945.
But bubbles always burst, because they are
financed with debt, which expands like a chain letter for the economy as a
whole. Mortgage debt service absorbs more and more of the rental value of real
estate, and of homeowners’ income as new buyers take on more debt to buy homes
that are rising in price.
Tracking the upsweep of savings and the
debt-financed rise in housing prices turned out to be the best way to
understand how most “paper wealth” has been created (or at least inflated) over
the past century. Yet despite the fact that the economy’s largest asset is real
estate – and is both the main asset and largest debt for most families – the
analysis of land rent and property valuation did not even appear in the courses
that I was taught in the evenings working toward my economics PhD.
When I finished my studies in 1964, I joined
Chase Manhattan’s economic research department as its balance-of-payments
economist. It was proved another fortunate on-the-job training experience, because
the only way to learn about the topic was to work for a bank or government
statistical agency. My first task was to forecast the balance of payments of
Argentina, Brazil and Chile. The starting point was their export earnings and
other foreign exchange receipts, which served as were a measure of how much
revenue might be paid as debt service on new borrowings from U.S. banks.
Just as mortgage lenders view rental income as a
flow to be turned into payment of interest, international banks view the hard-currency
earnings of foreign countries as potential revenue to be capitalized into loans
and paid as interest. The implicit aim of bank marketing departments – and of
creditors in general – is to attach the entire economic surplus for payment of
debt service.
I soon found that the Latin American countries I
analyzed were fully “loaned up.” There were no more hard-currency inflows
available to extract as interest on new loans or bond issues. In fact, there
was capital flight. These countries could only pay what they already owed if
their banks (or the International Monetary Fund) lent them the money to pay the
rising flow of interest charges. This is how loans to sovereign governments
were rolled over through the 1970s.
Their foreign debts mounted up at compound
interest, an exponential growth that laid the ground for the crash that
occurred in 1982 when Mexico announced that it couldn’t pay. In this respect,
lending to Third World governments anticipated the real estate bubble that
would crash in 2008. Except that Third World debts were written down in the
1980s (via Brady bonds), unlike mortgage debts.
My most important learning experience at Chase
was to develop an accounting format to analyze the balance of payments of the
U.S. oil industry. Standard Oil executives walked me through the contrast
between economic statistics and reality. They explained how using “flags of
convenience” in Liberia and Panama enabled them to avoid paying income taxes
either in the producing or consuming countries by giving the illusion that no
profits were being made. The key was “transfer pricing.” Shipping affiliates in
these tax-avoidance centers bought crude oil at low prices from Near Eastern or
Venezuelan branches where oil was produced. These shipping and banking centers –
which had no tax on profits – then sold this oil at marked-up prices to
refineries in Europe or elsewhere. The transfer prices were set high enough so
as not to leave any profit to be declared.
In balance-of-payments terms, every dollar spent
by the oil industry abroad was returned to the U.S. economy in only 18 months.
My report was placed on the desks of every U.S. senator and congressman, and
got the oil industry exempted from President Lyndon Johnson’s
balance-of-payments controls imposed during the Vietnam War.
My last task at Chase dovetailed into the dollar
problem. I was asked to estimate the volume of criminal savings going to
Switzerland and other hideouts. The State Department had asked Chase and other
banks to establish Caribbean branches to attract money from drug dealers,
smugglers and their kin into dollar assets to support the dollar as foreign
military outflows escalated. Congress helped by not imposing the 15 percent
withholding tax on Treasury bond interest. My calculations showed that the most
important factors in determining exchange rates were neither trade nor direct
investment, but “errors and omissions,” a euphemism for “hot money.” Nobody is
more “liquid” or “hot” than drug dealers and public officials embezzling their
country’s export earnings. The U.S. Treasury and State Department sought to
provide a safe haven for their takings, as a desperate means of offsetting the
balance-of-payments cost of U.S. military spending.
In 1968 I extended my payments-flow analysis to
cover the U.S. economy as a whole, working on a year’s project for the (now
defunct) accounting firm of Arthur Andersen. My charts revealed that the U.S.
payments deficit was entirely military in character throughout the 1960s. The
private sector – foreign trade and investment – was exactly in balance, year
after year, and “foreign aid” actually produced a dollar surplus (and
was required to do so under U.S. law).
My monograph prompted an invitation to speak to
the graduate economics faculty of the New School in 1969, where it turned out
they needed someone to teach international trade and finance. I was offered the
job immediately after my lecture. Having never taken a course in this subject
at NYU, I thought teaching would be the best way to learn what academic theory
had to say about it.
I quickly discovered that of all the
subdisciplines of economics, international trade theory was the silliest.
Gunboats and military spending make no appearance in this theorizing, nor do
the all-important “errors and omissions,” capital flight, smuggling, or
fictitious transfer pricing for tax avoidance. These elisions are needed to
steer trade theory toward the perverse and destructive conclusion that any
country can pay any amount of debt, simply by lowering wages enough to pay creditors.
All that seems to be needed is sufficient devaluation (what mainly is devalued
is the cost of local labor), or lowering wages by labor market “reforms” and
austerity programs. This theory has been proved false everywhere it has been
applied, but it remains the essence of IMF orthodoxy.
Academic monetary theory is even worse. Milton
Friedman’s “Chicago School” relates the money supply only to commodity prices
and wages, not to asset prices for real estate, stocks and bonds. It pretends
that money and credit are lent to business for investment in capital goods and
new hiring, not to buy real estate, stocks and bonds. There is little attempt
to take into account the debt service that must be paid on this credit,
diverting spending away from consumer goods and tangible capital goods. So I
found academic theory to be the reverse of how the world actually works. None
of my professors had enough real-world experience in banking or Wall Street to
notice.
I spent three years at the New School developing
an analysis of why the global economy is polarizing rather than converging. I
found that “mercantilist” economic theories already in the 18th century were
ahead of today’s mainstream in many ways. I also saw how much more clearly
early economists recognized the problems of governments (or others) relying on
creditors for policy advice. As Adam Smith explained, a creditor of the public,
considered merely as such, has no interest in the good condition of any
particular portion of land, or in the good management of any particular portion
of capital stock. … He has no inspection of it. He can have no care about it.
Its ruin may in some cases be unknown to him, and cannot directly affect him.
The bondholders’ interest is solely to extricate
as much as they can as quickly as possible with little concern for the social
devastation they cause. Yet they have managed to sell the idea that sovereign
nations as well as individuals have a moral obligation to pay debts, even to
act on behalf of creditors instead of their domestic populations.
My warning that Third World countries would not
to be able to pay their debts disturbed the department’s chairman, Robert
Heilbroner. Finding the idea unthinkable, he complained that my emphasis on
financial overhead was distracting students from the key form of exploitation:
that of wage labor by its employers. Not even the Marxist teachers he hired
paid much attention to interest, debt or rent extraction.
I found a similar left-wing aversion to dealing
with debt problems when I was invited to meetings at the Institute for Policy
Studies in Washington. When I expressed my interest in preparing the ground for
cancellation of Third World debts, IPS co-director Marcus Raskin said that he
thought this was too far off the wall for them to back. (It took another
decade, until 1982, for Mexico to trigger the Latin American “debt bomb” by
announcing its above-noted inability to pay.)
In 1972 I published my first major book, Super Imperialism: The Economic Strategy of
American Empire, explaining how taking
the U.S. dollar off gold in 1971 left only U.S. Treasury debt as the basis for
global reserves. The balance-of-payments deficit stemming from foreign military
spending pumped dollars abroad. These ended up in the hands of central banks
that recycled them to the United States by buying Treasury securities – which
in turn financed the domestic budget deficit. This gives the U.S. economy a
unique free financial ride. It is able to self-finance its deficits
seemingly ad infinitum. The balance-of-payments deficit actually ended up
financing the domestic budget deficit for many years. The post-gold
international financial system obliged foreign countries to finance U.S. military
spending, whether or not they supported it.
Some of my Wall Street friends helped rescue me
from academia to join the think tank world with Herman Kahn at the Hudson
Institute. The Defense Department gave the Institute a large contract for me to
explain just how the United States was getting this free ride. I also began
writing a market newsletter for a Montreal brokerage house, as Wall Street
seemed more interested in my flow-of-funds analysis than the Left. In 1979 I
wrote Global Fracture:
The New International Economic Order, forecasting how U.S.
unilateral dominance was leading to a geopolitical split along financial lines,
much as the present book’s international chapters describe the strains
fracturing today’s world economy.
Later in the decade I became an advisor to the
United Nations Institute for Training and Development (UNITAR). My focus here
too was to warn that Third World economies could not pay their foreign debts.
Most of these loans were taken on to subsidize trade dependency, not
restructure economies to enable them to pay. IMF “structural adjustment”
austerity programs – of the type now being imposed across the Eurozone – make
the debt situation worse, by raising interest rates and taxes on labor, cutting
pensions and social welfare spending, and selling off the public infrastructure
(especially banking, water and mineral rights, communications and
transportation) to rent-seeking monopolists. This kind of “adjustment” puts the
class war back in business, on an international scale.
The capstone of the UNITAR project was a 1980
meeting in Mexico hosted by its former president Luis Echeverria. A fight broke
out over my insistence that Third World debtors soon would have to default.
Although Wall Street bankers usually see the handwriting on the wall, their
lobbyists insist that all debts can be paid, so that they can blame countries
for not “tightening their belts.” Banks have a self-interest in denying the
obvious problems of paying “capital transfers” in hard currency. My experience
with this kind of bank-sponsored junk economics infecting public agencies
inspired me to start compiling a history of how societies through the ages have
handled their debt problems. It took me about a year to sketch the history of
debt crises as far back as classical Greece and Rome, as well as the Biblical
background of the Jubilee Year. But then I began to unearth a prehistory of
debt practices going back to Sumer in the third millennium BC. The material was
widely scattered through the literature, as no history of this formative Near
Eastern genesis of Western economic civilization had been written.
It took me until 1984 to reconstruct how
interest-bearing debt first came into being – in the temples and palaces, not
among individuals bartering. Most debts were owed to these large public
institutions or their collectors, which is why rulers were able to cancel debts
so frequently: They were cancelling debts owed to themselves, to prevent
disruption of their economies. I showed my findings to some of my academic
colleagues, and the upshot was that I was invited to become a research fellow
in Babylonian economic history at Harvard’s Peabody Museum (its anthropology
and archaeology department).
Meanwhile, I continued consulting for financial
clients. In 1999, Scudder, Stevens & Clark hired me to help establish the
world’s first sovereign bond fund. I was told that inasmuch as I was known as
“Dr. Doom” when it came to Third World debts, if its managing directors could
convince me that these countries would continue to pay their debts for at least
five years, the firm would set up a self-terminating fund of that length. This
became the first sovereign wealth fund – an offshore fund registered in the
Dutch West Indies and traded on the London Stock Exchange.
New lending to Latin America had stopped,
leaving debtor countries so desperate for funds that Argentine and Brazilian
dollar bonds were yielding 45 percent annual interest, and Mexican
medium-term tessobonos over 22 percent. Yet attempts to sell the
fund’s shares to U.S. and European investors failed. The shares were sold in
Buenos Aires and San Paolo, mainly to the elites who held the high-yielding
dollar bonds of their countries in offshore accounts. This showed us that the
financial managers would indeed keep paying their governments’ foreign debts,
as long as they were paying themselves as “Yankee bondholders” offshore. The
Scudder fund achieved the world’s second highest-ranking rate of return in
1990.
During these years I made proposals to
mainstream publishers to write a book warning about how the bubble was going to
crash. They told me that this was like telling people that good sex would stop
at an early age. Couldn’t I put a good-news spin [on the dark forecast] and
tell readers how they could get rich from the coming crash? I concluded that
most of the public is interested in understanding a great crash
only after it occurs, not during the run-up when good returns are to
be made. Being Dr. Doom regarding debt was like being a premature anti-fascist.
So I decided to focus on my historical research
instead, and in March 1990 presented my first paper summarizing three findings
that were as radical anthropologically as anything I had written in economics.
Mainstream economics was still in the thrall of an individualistic “Austrian”
ideology speculating that charging interest was a universal phenomena dating
from Paleolithic individuals advancing cattle, seeds or money to other
individuals. But I found that the first, and by far the major creditors were
the temples and palaces of Bronze Age Mesopotamia, not private individuals
acting on their own. Charging a set rate of interest seems to have diffused
from Mesopotamia to classical Greece and Rome around the 8th century BC. The
rate of interest in each region was not based on productivity, but was set
purely by simplicity for calculation in the local system of fractional
arithmetic: 1/60th per month in Mesopotamia, and later 1/10th per year for
Greece and 1/12th for Rome.
Today these ideas are accepted within the
assyriological and archaeological disciplines. In 2012, David Graeber’s Debt: The First Five Thousand Years tied
together the various strands of my reconstruction of the early evolution of
debt and its frequent cancellation. In the early 1990s I had tried to write my
own summary, but was unable to convince publishers that the Near Eastern
tradition of Biblical debt cancellations was firmly grounded. Two decades ago
economic historians and even many Biblical scholars thought that the Jubilee
Year was merely a literary creation, a utopian escape from practical reality. I
encountered a wall of cognitive dissonance at the thought that the practice was
attested to in increasingly detailed Clean Slate proclamations.
Each region had its own word for such
proclamations: Sumerian amargi, meaning a return to the “mother” (ama)
condition, a world in balance; Babylonian misharum, as well
as andurarum, from which Judea borrowed as deror, and
Hurrian shudutu. Egypt’s Rosetta Stone refers to this tradition of amnesty
for debts and for liberating exiles and prisoners. Instead of a sanctity of
debt, what was sacred was the regular cancellation of agrarian debts
and freeing of bondservants in order to preserve social balance. Such amnesties
were not destabilizing, but were essential to preserving social and economic
stability.
To gain the support of the assyriological and
archaeological professions, Harvard and some donor foundations helped me
establish the Institute for the Study of Long-term Economic Trends (ISLET). Our
plan was to hold a series of meetings every two or three years to trace the
origins of economic enterprise and its privatization, land tenure, debt and
money. Our first meeting was held in New York in 1984 on privatization in the
ancient Near East and classical antiquity. Today, two decades later, we have
published five volumes rewriting the early economic history of Western
civilization. Because of their contrast with today’s pro-creditor rules – and
the success of a mixed private/public economy – I make frequent references in
this book to how earlier societies resolved their debt problems in contrast
with how today’s world is letting debt polarize and enervate economies.
By the mid-1990s a more realistic modern
financial theory was being developed by Hyman Minsky and his associates, first
at the Levy Institute at Bard College and later at the University of Missouri
at Kansas City (UMKC). I became a research associate at Levy writing on real
estate and finance, and soon joined Randy Wray, Stephanie Kelton and others who
were invited to set up an economics curriculum in Modern Monetary Theory (MMT)
at UMKC. For the past twenty years our aim has been to show the steps needed to
avoid the unemployment and vast transfer of property from debtors to creditors
that is tearing economies apart today.
I presented my basic financial model in Kansas
City in 2004, with a chart that I repeated in my May 2006 cover story
for Harper’s. The Financial Times reproduced the chart in
crediting me with [as] being one of the eight economists to forecast the 2008
crash. But my aim was not merely to predict it. Everyone except economists
saw it coming. My chart explained the exponential financial dynamics that make
crashes inevitable. I subsequently wrote a series of op-eds for
the Financial Times dealing with Latvia and Iceland as dress
rehearsals for the rest of Europe and the United States.
The disabling force of debt was recognized more
clearly in the 18th and 19th centuries (not to mention four thousand
years ago in the Bronze Age). This has led pro-creditor economists to exclude
the history of economic thought from the curriculum. Mainstream economics has
become blindly pro-creditor, pro-austerity (that is, anti-labor) and
anti-government (except for insisting on the need for taxpayer bailouts of the
largest banks and savers). Yet it has captured Congressional policy,
universities and the mass media to broadcast a false map of how economies work.
So most people see reality as written by the One Percent, and it is a travesty
of reality.
Spouting ostensible free market ideology, the
pro-creditor mainstream rejects what the classical economic reformers actually
wrote. One is left to choose between central planning by a public bureaucracy,
or even more centralized planning by Wall Street’s financial bureaucracy. The
middle ground of a mixed public/private economy has been all but forgotten,
denounced as “socialism.” Yet every successful economy in history has been a
mixed economy.
__________________________________________
This essay is excerpted from the introduction
to Killing the Host.
Michael Hudson’s new book, Killing the Host is published in e-format by CounterPunch
Books and in print by Islet.
He can be reached via his website, mh@michael-hudson.com
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