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By Eric Janszen
Since the early 1980s the US economy has become more feudalistic. Economic liberalization that was promised under the Reagan administration and carried forward by both Democratic and Republic party leadership ever since has succeeded in reducing economic rent on wage earners extracted by government in the form of taxes, formerly spent inefficiently on public goods, in exchange for increased economic rent by banks in the form of interest on debt, the money spent efficiently to increase the scale of the financial sector of the economy at the expense of the goods and services sectors.
This week’s quick comment is a preamble to an extensive new interview with Prof. Michael Hudson on the Failure of Centralized Financial Planning.
Prof. Hudson was brought to my attention over a year ago by a member of our swelling iTulip community, now over 8,000 strong. Doctors, scientists, financial professionals, and business owners comprise the core of our international community who contribute from 80 countries to give iTulip its uniquely international perspective. But you don’t have to hold a doctorate, work at an investment bank, or run a company to get something out of iTulip. All you need is an open and inquisitive mind.
Our editorial policies are intended to avoid devolving into a right or left wing ideological echo chamber. We measure successful political equilibrium in the equal number of complaints we receive from the left for right wing editorial bias as from the right for left wing bias. We can even quantify this using Quantcast data that show in the “Brand and Site Affiliates” category that in “Politics & Commentary” iTulip scores an affinity of 131.7x with right wing lewrockwell.com, 90.4x with the more politically neutral The Economist, 66.5x from the left leaning truthout.org and 51.0x from the left sympathetic alternet.org. We thus net out to a near zero political affiliation. Perfect.
That said, as the founder and managing editor of iTulip, Inc. I have preferences and these are expressed throughout the site.
The bedrock of our philosophy is that allocation of capital within an economy is better done by markets than by governments. That said, government plays a key role in markets. A market is like a highway of money. Without rules and enforcement of rules and upkeep markets cannot function. Consider by analogy your morning commute on a highway without lanes, or speed limits or police enforcing them, or repairs to potholes or taxes to pay for them, or restrictions that keep trucks from over-filling their beds and spilling loads of rocks or steel bars onto the asphalt ahead of you. You can find such conditions in many third world countries where the institutions that set and enforce the rules of the road are weak. When accidents inevitably occur there, emergency teams come to the rescue of the most prominent and wealthy commuters, leaving everyone else to fend for themselves.
That anyone might choose to turn our once high functioning first world market highway into a third world version intentionally may strike readers as absurd, but that is precisely what has been done here in the US, UK and other countries over the past 30 years, paradoxically, by a politically motivated, ideological application of the concept of free markets.
Just as a highway free of lanes and speed limits and police is not truly free, our debt markets, for example, have become dominated by the will of the largest and fastest drivers, pushing as hard and as fast as they can in competition with each other, weaving and in and out among the rest of us as we poke along with our mundane consumer and business borrowing needs, as they use rarefied securitized debt instruments to fund uneconomical leveraged buyouts and mortgage loans, inevitably leading to the kind of massive slow motion pileup that has been going on here since July 2007. As the rest of us squeeze by in the credit market breakdown lane, less able to fund even sound and simple borrowing, like some third world, privately owned fire squad the Federal Reserve enters to backstop the entire debt risk polluted financial system on behalf of its owners, with whom we share the road.
The argument for rescuing the owners of The System, as Greenspan is fond of calling it, is that without them The System is destined to collapse, taking the entire economy down with it. While that is certainly true in the short term it is only so in the sense that commuters who used to get to work by train and now by car depend on government to prevent the collapse of bridges and tunnels because previously existing public transportation was dismantled by automobile and tire manufacturers. One novel approach is to let the weak and careless financial institutions fail so that better banks with more capable management can replace them. And while we're at it let the Fed fail and turn the function of printing money back over to the Treasury Department. Allowing insolvent banks to fail is called market clearing, and it's an effective way to get the financial system debris off the highway, and perfectly fair since it got there via the same hands-off approach.
But don't hold your breath; it's an election year.
Unbalanced Interests
Our Mad Max markets came about because the institutions that govern our markets receive out-sized financial influence from anti-government, anti-regulation political groups. For evidence, we recommend OpenSecrets.org, your trusted source of money in politics data. As pro-entrepreneur, free-market believers we have since iTulip was funded in 1998 been on the side of less government, yet seeing the lop-sided development of the FIRE Economy first hand we find ourselves pressing an agenda of constructive restoration of balance of financial and productive interests.
An economic system is healthy when political groups pressing for less government and regulation face off with equally capable groups pushing for more government and more regulation; rational economic policy results from the outcome of a balanced fight between nearly equal opponents, with each giving up something to the other to arrive at compromise. An overpowering pro-big government group produces socialistic policies that reduce incentives to build on dreams of creating a new business to solve a problem and create wealth, choking off the engine of entrepreneurship and growth by taxation and income re-distribution; an outsized small government group will and has led to a system of debt-serf neo-feudalism, to use Hudson’s term, that extracts economic surplus via interest on debt as debt dependence crept over the past 25 years into every aspect of life so that it is now needed to fund basic needs, from housing, food, and energy to education to health care.
A friend who came to the US from the Soviet Union in the 1970s told me the following 25 years ago, not long after I got out of college, which I will never forget: "America has accomplished what the Soviet system promised us but failed to deliver. Here you can start a business, compete, fail, try again, maybe eventually succeed and get rich, if you stick with it. Or you can live out your days working for some big company. If you start off stuck in a low paying job you can still save up money to go to college, or go at night and pay as you go with the money from your day job, or if you are married one of you can work while the other goes to college to develop skills needed for a higher paying job. So many ways to get ahead and make money, and if you fail there’s a government safety net so you don't starve."
He was impressed with the US system then, but he recently he told me he does not believe what he told me more than two decades ago is true anymore. Since then the purchasing power of income has so far eroded relative to the cost of the basic necessities of housing and food that a person starting at the bottom cannot save enough to go to college, both spouses in a marriage have to work to pay the bills to live in a safe neighborhood and to maintain a decent standard of living, and have to make very good incomes to afford to live in a town with good schools. If you are working a low paying field you have to work two or more jobs just to earn enough to have a place to live and food to eat, leaving no spare time for night school. This phenomenon was documented in nickledandimed. College is so expensive that you can no longer pay as you go; you have to take out student loans. If your credit isn't good then you cannot get a loan to pay for college. Even if you get in you graduate with so much debt that it's not economical unless you are training for a profession that earns you enough money to pay off student debt in perhaps10 years.
What happened? How under an economic system dominated by the ideology of small government and limited government interference in markets over 25 years did this radical transformation of the US society come about?
Since the early 1980s the US economy has become more feudalistic. Economic liberalization that was promised under the Reagan administration and carried forward by both Democratic and Republic party leadership ever since has succeeded in reducing economic rent on wage earners extracted by government in the form of taxes, formerly spent inefficiently on public goods, in exchange for increased economic rent by banks in the form of interest on debt to be spent efficiently to increase the scale of the financial sectors of the economy at the expense of the goods and services sectors of the economy.
This transformation is clearly evident in the numbers that show the growth rate of financial sector debt compared to all other sectors since 1980.
At the same time as innovative companies like google developed, the US economy become geared to increasingly maximize the extraction of economic rent. To those of us who come from the technology industry, the development of the FIRE Economy has occurred as kind of parallel universe intersecting only at the point of home ownership and the hoped for “liquidity event” of an IPO or acquisition via an M&A deal.
As an example of how the FIRE Economy dominates, consider the government subsidies of the real estate industry that encourage indebtedness in the name of “investment.”
Under 26 U.S.C. § 163(h) of the Internal Revenue Code, the United States allows a home mortgage interest deduction, with several limitations. ...there are additional tax incentives for home ownership. For example, taxpayers are allowed an exclusion of up to $250,000 ($500,000 for a married couple filing jointly) of capital gains on the sale of real property if the owner used it as primary residence for two of the five years before the date of sale. Furthermore, U.S. taxpayers are not taxed on imputed income derived from home ownership. (Wikipedia)
Compare this to the policies of a country with a reputation among libertarians for “socialistic” government policies.France does not allow a home mortgage interest deduction. In 2007, newly-elected President Nicolas Sarkozy proposed creating the deduction as part of his legislative plan for sparking the French economy. In August 2007, the Constitutional Council, the highest court in France, struck down the mortgage interest deduction as unconstitutionally creating a tax advantage that goes far beyond its stated goal of encouraging non-homeowners to buy homes. (Wikipedia)
Posing as a tax cut, the mortgage interest rate deduction is seen in countries like France and Germany for what it is, a shift in the tax burden from property owners to non-property owners and an incentive to increase indebtedness and debt payments to banks and away from paying taxes to government. As another example consider the US response to the latest financial crisis and the response of the purportedly more socialistic Norwegian government to its crisis in the early 1990s.
Key features of the Norwegian crisis resolution
There are five features of the Norwegian resolution I would like to highlight:
How does this compare to the US response to crisis over the past year?There are five features of the Norwegian resolution I would like to highlight:
- Private solutions were explored before the government intervened.
- Share capital was written down to zero before committing public funds.
- The government acted swiftly to limit contagion, but did not provide a blanket guarantee.
- Liquidity support was given to illiquid, but solvent institutions.
- The government did not use an asset management company - as the other Nordic countries did later on. (A Norwegian perspective on banking crisis resolution, Norges Bank, June 2005)
- Private solutions were explored before the government intervened.
- Share capital was written down to zero before committing public funds.
- The government acted swiftly to limit contagion, but did not provide a blanket guarantee.
- Liquidity support was given to illiquid, but solvent institutions.
The Federal Reserve arranged acquisition of Bear Stearns by JP Morgan Chase is emblematic of US policy. Here is what a former top Fed official had to say about the Bear Stearns bailout by the Fed.
A former top Federal Reserve official has said that the Fed's bailout of Bear Stearns Cos (BSC.N: Quote, Profile, Research) will come to be viewed as the "worst policy mistake in a generation," the Wall Street Journal reported on Tuesday.
Vincent Reinhart, who used to be the Fed's director of monetary affairs and the secretary of its policy making panel, said the event would be compared to "the great contraction" of the 1930s and "the great inflation" of the 1970s, the Journal reported.
The Fed, which is working to stabilize the markets, had offered $30 billion of financing for Bear's assets to JPMorgan Chase & Co (JPM.N: Quote, Profile, Research), which offered to buy the ailing bank, and helped it sidestep a bankruptcy filing.
But the rescue "eliminated forever the possibility the Fed could serve as an honest broker," Reinhart told the Journal, pointing to other options like looking for other suitors and removing some assets from Bear's portfolio, which he said were possible but not pursued by the Federal Reserve. (Ex-Fed official criticizes Bear Stearns rescue: report, Reuters, April 28, 2008)
He’s not alone. Recently ex-Fed Chairman Paul Volcker had this to say: "Simply stated, the bright new financial system, for all its talented participants, for all its rich rewards, has failed the test of the marketplace," Volcker said during a speech Tuesday to the Economic Club of New York. "What has plainly been at risk is a disorderly unraveling of the mutual trust among respected market participants upon which any strong and efficient financial system must rest." (San Francisco Chronicle, April 13, 2008)Vincent Reinhart, who used to be the Fed's director of monetary affairs and the secretary of its policy making panel, said the event would be compared to "the great contraction" of the 1930s and "the great inflation" of the 1970s, the Journal reported.
The Fed, which is working to stabilize the markets, had offered $30 billion of financing for Bear's assets to JPMorgan Chase & Co (JPM.N: Quote, Profile, Research), which offered to buy the ailing bank, and helped it sidestep a bankruptcy filing.
But the rescue "eliminated forever the possibility the Fed could serve as an honest broker," Reinhart told the Journal, pointing to other options like looking for other suitors and removing some assets from Bear's portfolio, which he said were possible but not pursued by the Federal Reserve. (Ex-Fed official criticizes Bear Stearns rescue: report, Reuters, April 28, 2008)
The relationship between government and the financial system is demonstrably less free-market in the US than in Norway and the US real estate industry in has fewer characteristics of a free market than in France. How did this situation arise? Dogmatic adherence to free-market ideology by political groups seeking economic ends.
Pendulum Swings Left
In the post credit crisis period, as the credit crunch bites into the US economy and reinforces the recession that is developing as a result of the demise of the housing and mortgage bubbles, my concern is that our political system will tend to lurch back toward anti-market solutions and that the uniquely American system of private equity financing of technological entrepreneurship, already suffering from a cyclical downturn, will be critically weakened at precisely the time that the competition to invent and productize in every scientific field, from biotech to high tech, is heating up globally.
With this in mind, we offer our subscribers our latest interview with Prof. Hudson. He has consulted to governments to design trade and monetary policy for more than 40 years. Spend time in conversation with him, as I had a chance to in New York City recently, and you quickly learn that his criticisms of Thatcherite free market fundamentalism is as fervent as of Communist governments as of various autocratic governments posing as socialist around the world. He’s seen it all.
Readers will hear what they will hear in Hudson’s words. I hear a message of balance and an appeal to restore economic principles that made America strong.
Eric Janszen
Founder & President
iTulip, Inc.
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Interview with Prof. Michael Hudson: Failure of centralized financial planning - Spring 2008
• The Fed has not acted in the national interest
• American banks are driving the dollar down
• Interest rates have decoupled from the real economy
• Debt service has made the US uncompetitive
• Euro headed for US$2.50 unless Europe changes its policies
• The alternative to canceling debts is disruptive inflation or bankruptcy
• Economists will not be part of the political solution (thank heavens)
Excerpts
“The interests of finance are different from those of the production-and-consumption economy. In fact, they are becoming inherently antagonistic. Take for example the idea that you can help the economy by lowering interest rates. The aim is to bail out the financial sector by raising asset prices even further. People thought that asset price inflation would make them rich – the inflation that Mr. Greenspan called wealth creation. But borrowing to ride the wave of asset-price inflation leaves a legacy of interest and principal charges to be worked off. Asset prices are bid up on credit – that is, by debt leveraging."
“Helping the financial sector load down the economy with debt to bid up the price of housing makes prospective homebuyers pay more. And bidding up stock and bond prices increases the cost to future retirees of buying a retirement income. To make matters worse, asset-price inflation diverts spending into speculation, away from tangible investment in the real economy. So we are less able to work off our debts.”
“It’s hard to see how the Fed will get out of the corner into which it’s painted the economy. The Federal Reserve could fold up and turn everything back to the Treasury, if indeed there’s nothing it can do to cure the mistakes it made under Alan Greenspan’s tenure. In fact, there are many reasons to prefer that it rather than the central bank run monetary policy here and in other countries. It could be argued that no country really needs a central bank, given the mentality of central bankers these days.” more ($ Subscription) …
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