Europe’s sovereign debt crisis in historical perspective

Sankt Georgen University, Frankfurt, June 22, 2012

Michael Hudson’s new book The Bubble and Beyond can be purchased here.

The Eurozone lacks a central bank to do what most central banks are supposed to do: finance government deficits. To make matters worse, the Lisbon Agreement limits these deficits to 3% – too small to pull economies out of depression by offsetting private-sector debt deflation.

Even if central banks could monetize higher levels of deficit spending, there are good reasons not to subsidize unfair tax systems and tax cuts on the real estate and financial “free lunch” windfalls that classical economists urged to be the tax base. Under classical tax policy, Europe would not have had a land-price bubble in the first place. “Free lunch” economic rent would have become the tax base, not capitalized into bank loans to be paid out as interest. Government budgets would have been financed in a way that kept down property prices.

But bank lobbyists have blocked the Eurozone from creating a true central bank to finance public budget deficits. They also have reversed classical tax policy, un-taxing real estate and finance while putting the burden on labor, corporate profits and consumers by the turnover tax (VAT). These twin financial and fiscal policies have strengthened the wrong sectors and made the current sovereign debt crisis inevitable, turning it into a general economic and political crisis.

Having created this crisis, rentier interests are seeking to use it as an opportunity to dismantle social welfare spending, break the power of labor unions and transfer their losses onto the public sector. Privatizing profits and “socializing” the losses threatens to plunge the Eurozone into austerity and economic shrinkage – unless bad debts and bad loans are written down or off entirely.

Debts that can’t be paid, won’t be. The question is whether their non-payment will take the form of debt writedowns to the level that can be paid, or whether Europe will be subjected to a wave of foreclosures, privatizations and cutbacks in public spending on infrastructure and social programs. In discussing alternatives, it may help to remember that Germany’s Economic Miracle was grounded in the Allied Monetary Reform of 1947, which was a far-reaching debt cancellation. A similar debt write-off is needed to enable Europe to re-start with a Clean Slate (Schuldenstreichung) and a sounder financial and tax system. The need has now become urgent.

Such a financial reform needs to be accompanied by a tax reform to collect land rent, natural resource rent and to restore basic infrastructure monopolies to the public sector rather than leaving it as a windfall gain or “free” to be capitalized into a new wave of bank loans.

I want to start by saying how shocked I was a few years ago to find that Germans are being propagandized with a travesty of history regarding the Weimar hyperinflation in the 1920s. When I studied – and later, taught – graduate economics in the 1960s, the problem was clearly understood. Students learned how Germany was loaded down with reparations far beyond its ability to pay after World war I. Already in 1919, John Maynard Keynes’s Economic Consequences of the Peace warned that setting these reparations so high would cause a breakdown of international payments. During the 1920s he defined the limits to how much foreign debt or other “capital transfers” could be paid abroad.

Followed by a few economists such as Harold Moulton and Allyn Young in the United States, Keynes’s “structural” balance-of-payments analysis was taught to a generation of students and credit analysts. It became common knowledge that what governments might tax away in domestic currency was not necessarily available to be paid in foreign exchange. Germany could pay dollars or gold only by exporting more – or by selling property, or borrowing hard currency. What collapsed its exchange rate and inflated its prices was trying desperately to pay foreign debts, not printing money to spend at home. I realize that Germans are traumatized by inflation. Rather than being carried away by emotions, now it is time to take a step back and acknowledge the real reasons that caused the trauma.

Keynes and his colleagues failed to convince governments to reject the arguments of Jacques Rueff in France, Bertil Ohlin in the United States and other creditor-oriented economists claimed that there was no limit to how much money could be squeezed out simply by imposing financial and fiscal austerity. Their narrow-minded views received powerful support from creditor interests, backed by nationalistic American diplomacy. Their logic of revenge was not a responsible guide to policy. Yet it has survived in less emotional but equally cold, calculated form as rationalization for the International Monetary Fund’s austerity programs imposed on Latin American and other Third World debtors since the 1960s.

What is remarkable is that awareness of the empirically valid side of the 1920s German reparations debate has disappeared from today’s discussion. The losers in that debate – the austerity advocates – have swamped the popular media, government and even the universities with what psychologists call an implanted memory: a condition in which a patient is convinced that they have suffered a trauma that seems real, but which did not exist in reality. The German public has been given a false memory of its traumatic hyperinflation. The pretense is that this resulted from the Reichsbank financing domestic currency spending. The true explanation is to be found in the foreign currency collapse – trying to pay foreign debts far beyond the ability to do so.

Every hyperinflation in history has been caused by foreign debt service collapsing the exchange rate. The problem almost always has resulted from wartime foreign currency strains, not domestic spending. The dynamics of hyperinflation traced in such classics as Salomon Flink’s The Reichsbank and Economic Germany (1931) have been confirmed by studies of the Chilean and other Third World inflations. First the exchange rate plunges as economies pay for foreign military spending during the war, and then – in Germany’s case – reparations after the war ends. These payments lead the exchange rate to fall, increasing the price in domestic currency of buying imports priced in hard currencies. This price rise for imported goods creates a price umbrella for domestic prices to follow suit. More domestic money is needed to finance economic activity at the higher price level. This German experience provides the classic example.

In 1919 the Allies imposed unpayably high reparations on Germany – largely to pay the Inter-Ally arms debts that the U.S. Government insisted on collecting from Britain and France for supplies and weapons sold before the United States entered the war. Such debts traditionally were forgiven among allies upon achieving victory. But the U.S. Government refused to do this, so its wartime customers turned to Germany to pay.

Its liability was unlimited under the Treaty of Versailles. For starters, Germany was stripped of its coal reserves, steel mills and other valuable assets. This left little alternative but for the Reichsbank to create German marks to throw onto the currency markets to obtain the foreign exchange to pay reparations. This raised the price of imports, and hence the domestic price level. More money was needed to transact purchases and sales at the higher price level. So the line of causation went from the balance of payments and currency depreciation to rising import prices. More expensive imported goods raised domestic prices as well. It was this that created a need for a higher money supply, not domestic money that forced higher prices.[1]

Germany’s mark was stabilized and reparations were paid by borrowing abroad, not by taxing domestic income. Its cities borrowed dollars in New York and turned the proceeds over to the Reichsbank in exchange for domestic currency (whose spending did not cause domestic price inflation). The Reichsbank paid these dollars to the Allies – which turned around and paid the money to the U.S. Government for their arms debts in a triangular circulation.

The Federal Reserve flooded Wall Street with enough credit to keep interest rates low enough to encourage foreign lending to obtain higher interest rates abroad. This appeared to make the system work – by financing debt service with new borrowing. Economists call this a Ponzi scheme (Schneeballsystem). What promises to be the “miracle of compound interest” cannot last for long without self-destructing. The low U.S. rates that made foreign lending profitable fueled a domestic real estate and stock market bubble that crashed in 1929.

It may seem strange for an American such as myself to be invited to Germany to tell you about your own history. But that is what happens when bank lobbyists skillfully exploit a collective trauma to strip a nation of knowledge of its history and replace it with a travesty of reality. This distortion of history is a precondition for spreading the creditor-oriented ideology advocated by the EU Commission, European Central Bank (ECB) and International Monetary Fund (IMF). This “troika,” captured and caged by neoliberal ideology, is using a false historical view to plunge Europe into needless austerity and poverty.

The most immediate decision was to do to Greece what the Versailles Treaty did to Germany: enforce foreign debt service far beyond its ability to pay. Politically, this requires suspending democracy and accepting the possibility of Greece slipping back into military dictatorship, by insisting that populations not be given a voice in whether to approve government’s commitment to pay. The veritable coup d’état is capped by replacing elected governments in Greece and Italy with “technocrats,” Euro-speak for what we Americans call investment bank lobbyists or factotums.

When you find wrong-headed ideological economics promoted year after year as a litany, there always is a special interest at work. Today’s most powerful special interest is the financial sector. It is seeking to extract gains even at the cost of imposing austerity and ultimate bankruptcy on entire national economies. Pro-creditor lobbying has gained enough subsidy and power to strip the history of economic thought from the academic curriculum, to the point of suppressing memory of monetary debates going back two centuries. Today’s monetarist insistence that foreign debts can be paid without limit, for example, is rooted in David Ricardo’s Bullionist logic put forth in the 1820s. It was controverted by the anti-Bullionists, yet universities still teach Milton Friedman’s Chicago School blind spots, and central banks throughout the world enforce its errors of omission and commission.

This censorship of past intellectual history is not science, nor is it empirically based. It is ideology reflecting brute self-interest by creditors. But its rationalization of Eurozone strictures against central banks financing public spending is used to brainwash the economics profession and the ranks of central bankers submissive to investment bankers. There is even an ideology that government budgets should be balanced rather than provide the economy with money and purchasing power to grow. The policy conclusion reveals the motivation why for this error has been popularized so successfully: If central banks do not provide the economy with money (in the form of money-debt that nobody expects actually to be paid over time, unlike commercial bank credit), then this leaves private-sector banks as the only source of money and credit – and charging interest. Their aim is to keep for themselves the monopoly of creating money that governments could do just as well on their own computer keyboards.

Banks have shown themselves to be irresponsible in financing the characteristic form of price inflation of today’s world: a financial bubble fueled by credit on easier and looser terms to buy real estate, stocks and bonds, to buy entire companies. Governments hardly could have been expected to fuel asset-price inflation. Their interest is in taxing away “free lunch” windfalls from the land’s rising site value and from natural resources, and to provide basic infrastructure services at subsidized prices or freely, just as they provide roads without tollbooth access charges. Banks have sought to enable mortgage debtors and corporate raiders to pay their interest by cutting taxes, leaving more land rent and corporate income “free” to be paid to bankers and bondholders rather than to the tax collector.

The result is to raise prices in two ways. First of all, “rent is for paying interest,” and so is corporate cash flow in today’s world of debt-leveraged buyouts, hedge fund takeovers, mergers and acquisitions. Whatever the tax collector relinquishes is “free” to be capitalized into higher bank loans, raising the price of assets. This raises prices for housing, of factories and other means of production. Economies polarize between creditors at the top of an increasingly steep pyramid, and debtors at the bottom sinking into debt peonage. The middle class melts away.

Tax cuts on land rent, natural resources and the higher income brackets force governments to shift the tax burden onto labor, industry and consumers. This raises the break-even cost of living and employing labor. This prices debt-ridden and regressively taxed economies out of world markets. The effect must be economic shrinkage – unless the entire world joins in this race to the bottom

The myth that Germany’s hyperinflation in the 1920s was caused by the Reichsbank using the printing press to finance Germany’s domestic budget deficit has survived to justify the Lisbon Treaty’s preventing the European Central Bank from creating money to lend to governments. Banks have spent a generation planting this false history to force governments to borrow commercially, at interest, presumably on risk-free terms. The ECB thus has been hijacked to serve commercial banks, not the public interest. Banks want to force governments to borrow commercially, at interest, presumably on risk-free terms. The aim is to monopolize the creation of money that governments could create just as well on their own computer keyboards.

Already in the 18th century, British economists such as Sir James Steuart, Rev. Josiah Tucker and even David Hume recognized that additional money and spending normally (as long as unemployment existed) helped increase output more than prices. The corollary is that monetary deflation in unemployment conditions tends to curtail output more than imports – not to speak of transferring property from creditors via foreclosure. So money is much more than a “veil.” It is debt, not merely a set of “counters.” Austerity discourages new capital investment, leading to deeper import dependency, worsening the balance of payments as well as the fiscal deficit.

By starving the economy of the funds to increase employment and output – while backing banks that have spent the past generation inflating real estate prices and the financial bubble – ECB policy has promoted asset price inflation for housing, living costs and hence employment costs. This hardly is a recommendation for leaving it with the central planning power it is seeking to impose austerity to squeeze out debt payments for its past irresponsible credit policy.

Something has to give. If debts are not written down – and indeed, written off – then economies will have to use their surplus to pay past creditors and their heirs rather than invest in economic growth and raising living standards. The financial plan is to dismantle government social spending and infrastructure investment, privatizing this – on credit, building heavy debt servicing charges into the prices of public services now provided at subsidized rates or freely, paid for by a combination of progressive income and wealth taxation and new government money creation. The effect will be to increase the national price structure, while making creditors and privatizers rich even as the overall economy shrinks.

A political and ideological coup d’état is replacing democracy with financial oligarchy, transferring government power to banks and bondholders. The new policy is not for governments to tax the wealthy but to borrow from them – at interest, which is to be paid by taxing labor, consumers and industry all the more. To proceed down this path would reverse Europe’s Enlightenment and the past three centuries of economics. It is called classical economics – and even “free market economics” – but it is a travesty to impose this policy in the name of the patron saints of classical political economy. The Physiocrats, Adam Smith, John Stuart Mill, Wilhelm Roscher, Friedrich List and Progressive Era reformers urged just the opposite path of what now is being taken, and indeed which the world seemed to be following until World War I and for a few decades after World War II.

The euro was crippled at the outset, financially and fiscally

The European Union was created largely as a project to end war, but the way the Eurozone has been shaped has opened an unanticipated form of warfare and tribute-seeking: a conquest waged by bankers and their major rentier clients to create a financial oligarchy ruling via “technocrats” installed much as proconsuls used to serve in the Roman Empire. Acting on the prime directive that all debts must be paid, willy-nilly, this administrative class is willing to plunge economies into austerity and depression to create an opportunity to break the power of labor unions and roll back social spending under force majeure conditions. Reversing the past two centuries of European Enlightenment, financial interests are fighting to reverse the Progressive Era’s reforms of a century ago and the social democracy that followed World War II.

Europe is being pushed into depression, but it is not a cyclical business downturn or a result of natural phenomena. It is not economically necessary, and certainly not the result of labor being overpaid – except to the extent that it is paid more to cover its payments to the banks. The sovereign debt crisis is being used as an opportunity to force privatization sell-offs and dismantle the power of governments to regulate and tax wealth. Budget deficits are used not to revive employment, Keynesian-style, but to save banks and bondholders from having to take a loss.

The first dimension of the Eurozone’s problem is financial. Bank lobbyists crippled the euro at its birth. Unlike Britain and the United States, the Eurozone lacks a central bank to do what central banks are supposed to do: create money to finance government budget deficits. The money and credit needed to fuel the economy are to be created by commercial banks, at interest. There simply is no continental European idea of a central bank lending directly to government.

This is why George Soros recently described the euro itself as a bubble – a positive feedback of belief that it would work has been followed by a sudden realization of its structural shortcoming. “The main source of trouble,” he explained, “is that the member states of the euro have surrendered to the European Central Bank their rights to create fiat money.”[2] Prevented from lending to governments, the ECB in its present form was bound to fail at the point where governments need to rescue economies from debt deflation.

The euro was created without a body able to monetize public spending independently of commercial banks. But the banks have lost too much to resume lending. Deregulation, lax oversight and outright fraudulent practice have become so rife, especially emanating from U.S. and British banks and their correspondents, that trust has been broken. Without faith, credit disappears, because the word credit means, literally, “I believe [that I will be repaid].” Bankers rightly fear to extend credit to other banks.

This is the end-game resulting from the fact that the banking system’s business plan has not been to finance new capital formation to create future income flows from the real economy, but to find assets and income streams to serve as collateral for new loans. As banks compete to lend against real estate (which accounts for some 80 percent of new bank lending in the United States and Britain), corporate control or stocks and bonds, the effect is to load these assets and their income stream with more debt, siphoning capital away from productive investment to pay interest and amortization to the banks. It is a predatory yet basically lazy business plan.

Unlike public deficit financing, commercial banks inflate prices – asset prices. Banks lend mainly against rent-extracting assets, headed by real estate, oil and gas, mining, and monopoly rent extraction – precisely the “free lunch” rent that classical economists urged to be the tax base. Land has passed out of ownership by hereditary aristocracies to be democratized – but on credit. Recognizing that whatever the tax collector relinquishes is “free” to be paid to the banks as interest, banks have thrown their weight behind un-taxing the land, fuels and minerals.

This fiscal dimension is the second depth charge in Europe’s economic malstructuring. A property’s price is however much a bank will lend. As bank officers seek to loan as much as borrowers will take, they loosen the terms, lending a rising proportion of the purchase price of real estate or other property. This raises asset prices – a result of higher debt leveraging, not actually earning or producing more. So more borrowers buy property simply hoping to make an asset-price (“capital”) gain. This is why commercial bankers love asset-price inflation. It broadens the market for their credit creation.

By deeming interest tax-deductible as if it were a necessary business expense (and even on owner-occupied residential real estate in most English-speaking countries), today’s pro-debt, pro-bank tax code subsidizes a rising proportion of the economic to be surplus paid out as interest to the bankers. This causes a loss not only to the tax collector, but also to the economy at large. New buyers of homes or commercial property, for instance, vie with other prospective buyers to see who will pledge the most after-tax income to obtain a bank loan. The result is that although governments do not fuel real estate and financial bubbles by lending or by central bank money creation, they help inflate asset prices by guaranteeing mortgage loans and un-taxing rent to pay higher mortgages.

To make matters worse, governments must make up the loss of property tax revenue by taxing wages and profits, or sales via the Value Added Tax (VAT). These taxes increase the economy’s cost of living and doing business, by raising the supply price of labor and tangible capital, and by raising the sales price by the amount of the excise tax. So what inflates asset prices is tax favoritism for debt leveraging, not central bank money creation as such.

This means that if economies are to be more competitive, they need to minimize the degree to which housing prices, education prices and public utility services are debt-leveraged and hence build interest charges into their prices. Over more than two centuries, economists have urged taxing away “unearned” income that has no counterpart in actual costs of production (“economic rent”) and either keeping natural monopolies in the public domain or at least regulating their prices to keep them in line with technologically necessary production costs.

Explaining this logic was what free market classical political economy was all about – and why it no longer is being taught by academic curricula run by today’s financialized travesty of “free market” ideology. The first act of the Chicago Boys in Chile after the Pinochet military junta took over in 1973, for example, was to close down every economics department in the country, except for the Catholic University where the Chicago School monetarists held sway. The teaching of economics became an exercise in censorship and brainwashing, not a scientific or empirical endeavor. Chile’s economy became “free” to be looted over the remainder of the 1970s, with nearly every pension fund being emptied out as companies were bankrupted for profit.

The French novelists Balzac (Le Père Goriot) and Zola (L’Argent) understood the dysfunctional dimension of wealth-seeking better than today’s economics textbooks. And most people today intuitively sense that banking and high finance has become predatory. Bill Black (UMKC) has described “control fraud” as a combination of crooked accounting, buying politicians, slandering whoever might expose the deception, and backing “free market” economists to assure the public that Wall Street will regulate itself without any need for regulatory oversight. Yet it wasn’t politically correct to say so until George Ackerlof won the 2001 Nobel Economics prize in large part for his 1993 article with Paul Romer on “Looting: The Economic Underworld of Bankruptcy for Profit.” Its thesis was straightforward: “Bankruptcy for profit will occur if poor accounting, lax regulation, or low penalties for abuse give owners an incentive to pay themselves more than their firms are worth and then default on their debt obligations. Bankruptcy for profit occurs most commonly when a government guarantees a firm’s debt obligations.”

Economics textbooks treat this as an anomaly – as if it shouldn’t exist, and therefore can be ignored as an accidental failure in the system, not its intention, focus and indeed its very essence. No textbook explains how the most recent fortunes have been made by grabbing other peoples’ savings – pension fund savings, and especially those of rival financial institutions. Yet Enron’s corruption of Arthur Andersen turned out to be symptomatic of the Big Five accounting firms, followed by bond ratings agencies that all gave AAA credit ratings to what turned out to be toxic subprime mortgages. Economics texts do not even explain (or defend the idea) that the way to get rich is to borrow money to buy a property that’s going up in price – and why debt-leveraged asset-price inflation must necessarily collapse in a wave of bankruptcy.

The financial sector’s business plan is to impose throughout Europe what the European Central Bank and “troika” partners are doing to Greece, Ireland, Portugal and Spain. They say: “Give us your ports and your land, your tourist sites and your water and sewer systems. Let us put up tollbooths on these privatizations to collect rents.” The buyers are to turn around and use the revenue to pay their bankers – while the governments receiving the buyout payment for this property turn around and pay their bondholders, including the bankers who hold these bonds as reserves.

Acting on behalf of these bankers and bondholders, central bank apparatchiks say, in effect: “Sorry our earlier advice to deregulate financial markets and untax wealth didn’t work out better. But you must take responsibility for the consequences of your policy decisions.”

In times past this kind of asset grab imposing rentier tribute required an army to enforce. What makes today’s situation so remarkable is that it is achieved without need for military intervention – as long as populations remain passive and believe that the world that works in the way that banks depict. Its promise is that “Austerity will make you rich,” much as if self-deprivation will make you holy. The corollary is that to become rich – or even to keep the economy functioning – banks have to be saved from taking a loss. And the unstated inference is that governments must absorb the loss and pass it on to “taxpayers.”

The reality is that losses are inevitable as debts go bad and drive a widening part of the economy into negative equity (debts in excess of assets). That is inherent in the mathematics of compound interest, and the result of steadily loosening loan standards to raise the degree of debt leveraging. Disabling popular opinion from realizing this fact is part of the weaponization of the economic theory, turning it into a combination of distraction, diversion and outright deception.

Matters are made much worse by the financial sector’s lobbying to untax the finance, insurance and real estate sector, as well as untax asset-price (“capital”) gains and the higher income brackets. Taken together, these policies have steered bank credit to finance a real estate and stock market bubble, not into creating new industrial capital, infrastructure or other productive lines.

I can understand German reluctance to finance the budget deficits of governments such as Greece that are unable or unwilling to tax the wealthy, and whose insiders control public spending and contracts. This would merely subsidize tax evasion and wrong-headed fiscal policy by ECB credit – provided ultimately by European taxpayers. The deep problem – which hardly has been discussed – is that Eurozone tax policy is the opposite of what classical economists defined as free markets – markets free of unearned income, headed by the land’s site value rent stemming from what is provided by nature and given value increasingly by public infrastructure spending (e.g., on transportation, water and sewer services) and the general level of prosperity. Economic rent is independent of the landowner’s, homeowner’s or mine owner’s own investment or costs. What makes it a free lunch is that, by definition, it has no counterpart in the recipient’s own outlays – except to finance the purchase a rent-extracting privilege or asset.

Instead of progressive taxation of land, natural resources and “unearned income” (economic rent), the tax system subsidizes debt creation and promotes asset-price inflation by giving favoritism to debt-leveraged price gains and making interest payments tax-exempt. This means that tax reform is needed to go with financial reform. The problem with Greece is not merely their widespread tax evasion by the wealthiest layer of the economy, which normally would pay most of the taxes (as was long the case in the leading industrial nations). Governments are taxing the wrong sources of income: wages and profits, instead of rent.

Under present conditions, the Eurozone’s collapse is unavoidable

The Eurozone’s economic collapse is not accidental. The bank lobbyists who captured the continent’s financial and tax policy planted the roots of the debt problems of Greece, Ireland, Spain, Italy and Portugal at the euro’s creation,

by not permitting the European Union to create a proper central bank to monetize government deficits. This obliges governments to borrow from banks at interest for creating credit that public central banks could do just as readily on their own computer keyboards. Creditors use the government’s need to roll over the public debt as a lever to impose austerity, euphemized as “confidence.” Instead of spurring confidence, the rise in interest rates and political crisis spurs a capital flight and bank run (viz. Greece and Spain). by forcing governments to minimize these deficits to only 3% of GDP – too low to spur recovery in the face of today’s debt deflation. by promoting an anti-progressive tax shift off real estate and finance (and the higher wealth brackets in general) onto wages and profits. This raises the cost of living and doing business – while lower property taxes leave more rent to be capitalized into bank loans. by un-taxing capital gains and deeming interest payments tax-deductible. This encourages debt leveraging to bid up prices for housing and other assets. Diverting savings into speculation makes rentier economies less competitive, and also less fair. by loosening bank regulations to permit unproductive bank lending to inflate asset prices rather than to finance new means of production. A race to the bottom has shifted the financial center to London, where deregulation has led to a free-for-all of irresponsibility (viz. the Icesave debacle), while in the United States financial fraud has been effectively de-criminalized. by bailing out banks and bondholders when the time finally comes for governments to create new debt in response to the financial crisis. Instead of increasing social spending or writing down bad debts and loans, governments (at ECB urging) take bad debts onto the public balance sheet, leaving the debt overhead in place. This exacerbates the debt deflation, shrinking economies all the more, reimbursing the 1% at the cost of impoverishing the 99%. This pits the financial sector not only against labor but against the productive economy at large.

Financial institutions have become more extractive than productive, not only directly as creditors and money managers, but also as lobbyists for tax rules that subsidize debt rather than direct investment. Once initiated, the debt overhead grows exponentially to a point that shrinks the economy’s ability to pay and invest productively, causing defaults and foreclosures. The banks’ policy response is to insist that governments replace bad private-sector loans with public debt.

This means creating money only to benefit the banks and other creditors, not to help the non-financial productive economy. Almost without voters noticing, the traditional role of government has been inverted to serve creditors, not the “real” economy. In principle (at least as popularly understood), central banks are supposed to spend to promote economic growth and full employment, not make financial returns by loading economies down with debt. But since 2008 the U.S. Federal Reserve has sought to re-inflate the financial bubble, not spur the “real” economy. EU governments, having had their monetary hands tied while commercial banks inflated asset prices far beyond the ability of debtors to pay, are now told to take bad debts onto their balance sheets (viz. Ireland, Greece, Portugal and Spain) and squeeze out enough additional tax revenue to pay interest to the happy bondholders who have got “cash for trash.” The fiction at work here is that austerity can squeeze out more money, rather than worsen the deficit. The moral outrage is that the 99% should be taxed to make the 1% whole – on its share of wealth, which has doubled during the financial bubble, as if this were built into the moral structure of nature itself! This is outrageous.

The unpayably high magnitude of debts is not accidental and cannot be cured by merely marginal reforms short of writing off the debt overhead. It is not possible to preserve the present financial structure and leave the debt overhead in place. This means that bank bailouts are in vain – except to enable existing speculators, depositors and investors to take their money and run. In contrast to the political cover story about how bailing them out will “restore confidence,” bankers are using central bank subsidy to abandon the economic ship. Sophisticated financial analysts know that in the end, the debt overhead must go bad. This is the reality that banks have sought to expurgate from the academic curriculum and, more important, from public consciousness – because it shows that the bailouts ultimately must be in vain.

The illusion of restoring stability can be sustained only by creating new government debt and bailouts to feed the exponentially growing debt overhead. The ECB is providing enough liquidity to banks to lend debtor governments enough to keep paying their bondholders and bail out bankers. This creates a financial echo chamber. Banks finance governments, which finance the banks. The U.S. Federal Reserve led the way by flooding the money markets with liquidity so that bankers could lend mortgage debtors enough to pay their debts falling due, even for property in negative equity (with the mortgage exceeding the market price).

The aim is to keep alive the illusion that debts can be paid by helping the economy “borrow its way out of debt.” Meanwhile, debt deflation prevents the economy from “earning its way out of debt.” In austerity-ridden economies, lending hardly can be productive, because there is little motive to invest as sales fall, retail stores close and more debtors default.

It thus seems absurd to think that bank propagandists can get much popular traction for their claim that the financial system will collapse unless governments bail them out. What they really want is simply to save their stockholders and bondholders from losing the outsized gains they have made over the past decade. Frightening scenarios are painted about how wiping out bank reserves will endanger depositors’ savings, because one party’s savings is another’s debt after all. So the 1% is to be bailed out as if this were all for the good of the 99% – the proverbial widows and orphans, and especially retirees and their pension funds, all of whom are conceptualized as living off trusts invested largely in bank bonds and hedge funds.

What needs to be recognized is that even if governments finance more deficit spending at this point, it is hard to see how this can rise to a magnitude sufficient to offset the impact of debt deflation – that is, the interest and amortization to carry past debts, whose payment leaves less income available for spending on goods and services.

The savings overhead is the problem, because this is synonymous with the debt overhead

It is time to ask whether it is desirable for economies to save, at least to save along present lines – even to save for retirement. The problem is that savings tend to concentrate wealth at the top of the economic pyramid, and to do this parasitically when they are lent out to become other parties’ debts. Restructuring the financial system is especially important for pension funding and Social Security, to re-organize it more along the lines of Germany’s pay-as-you-go system rather than financialized to make money by lending and speculation as in the United States.

The problem with our present system is that almost all financial savings today are lent out, rather than taking the form of new direct investment to increase the means of production or raise living standards. Most corporate investment is made out of retained earnings. Bank loans affect the corporate sector mainly by fueling takeovers and leveraged buyouts of companies already in place – and ripe for asset stripping.

This is not the happy picture that economic textbooks depict, with banks lending savings to factories with smokestacks coming out of them and workers walking with their lunch pails in, presumably to get the paychecks. Such misleading diagrams (at least in American textbooks) are intended to brainwash students to believe that finance plays an inherent symbiotic role with industry and the economy at large, rather than being an external intrusion – something that has been likened more to the relationship between locusts and a farm than to a mutually beneficial system. When debtors pay their bankers, they have less to spend on the real production-and-consumption economy. And when bankers make the loans that extract this income, the credit is not what people have saved, but what bankers have created on their own keyboard. “Loans create deposits,” not the other way around. And the vast majority of these loans are to buy assets already in place: to transfer the ownership of real estate, stocks and bonds on credit, bidding up their prices in the process – while deflating the “real economy.” This is why asset-price inflation finds its natural complement in debt deflation of the economy at large.

What textbooks should explain is that under today’s financial system, the more an economy saves, the more that is owed. This would not be such a problem if savings were lent out productively, in ways that enable the borrower to earn the income to pay off the debt with its interest. But the banking system’s business plan is to convince borrowers that they can pay debts by buying assets whose price is being raised by the exponential rise in bank credit. The idea is to lend more against every asset and income stream, by requiring smaller down payments and slower amortization of the debt balance. The trick is to convince borrowers that they are getting richer as long as prices for homes, stocks and bonds are rising faster than debt is increasing.

This asset-price rise increases the ratio of property to labor’s wage rate. And when prices plunge, the debts remain in place. This is what economic orthodoxy and its textbooks leave out of account. Yet it is the paradigmatic model of financial bubbles.

What is needed – after letting the present bubble crash by wiping out the bad-debt overhead – is to prevent a recurrence of the Bubble Economy, by restructuring the financial system along more productive lines. But banks are fighting tooth and nail against such a restructuring, because it means rejecting the Thatcher-Reagan epoch of Chicago School neoliberalism sponsored by the banks at the expense of the economy at large.

More immediately, this understanding of the dynamics of debts suggests a need for governments to provide a “public option” for saving as well as for money creation, credit cards and other financial infrastructure that is indeed necessary for the everyday economy to function efficiently. The aim should be to promote tangible capital formation and minimize the cost of living and doing business, not unproductive credit grounded in asset-price inflation and a financialized real estate bubble and stock market bubble.

The Quantitative Easing policies that have pushed down interest rates to just 1 percent in the United States and Britain. This has led pension plans and insurance companies to desperately seek higher rates of return – and they have done so by gambling on derivatives. Typically these have lost money, not given the hoped-for gains, as Wall Street sharpies have stuck their clients with bad interest-rate swaps and other deals gone bad. The usual excuse is made: “Nobody could have anticipated these problems. No one could have foreseen the crash.” But large swaths of the pension fund and insurance sector have been left with negative equity – while their managers have paid themselves enormous bonuses and stockholders enormous dividends during the run-up.

How asset-price inflation leads to debt deflation

Debts must be paid out of income earned elsewhere. And as the volume of debt rises, interest payments and other carrying charges divert personal and corporate income away from being spent on goods and services. (These payments also reduce tax receipts, because interest is ruled to be a tax-deductible expense.) Markets shrink, investment and employment slows, and debtors are less able to pay their stipulated debt service (or taxes). Debt deflation arrives, along with a fiscal squeeze – and it is deemed a crisis.

Just what really is this crisis? From the vantage point of wealthy creditors atop the economic pyramid, the problem is simply one of how the wealthiest 1 percent of the population – which has doubled its share of wealth over the past generation – can avoid having to give up its remarkable gains. These gains have been made as a result of indebting the bottom 99% and receiving the lion’s share of debt-leveraged asset-price gains. To avoid the seemingly normal recession of these gains, governments and the population as a whole must bear the loss. Families must lose, businesses must go under, local and national government may collapse and societies must suffer lower wage levels, so that banks and other creditors do not lose a penny.

This narcissism of wealth prompts creditors to pretend that the Bubble Economy’s fluorescence was normal, not a distortion. The wealthy and their financial institutions want to double their share of income and property again, and then to keep on increasing it even to the point where the rest of society is plunged into misery, labor emigrates, birth rates fall and the economy dies.

That is the result of “growth” of the financial system increasing asset prices by debt leveraging. It is not really new in the world. Isaiah decried creditors and landlords who placed house to house and plot to plot until there was no room left for people in the land.

Tying the hands of government by depriving it of a central bank to create money

The Progressive Era prior to World War I, and even economic democracy after World War II, envisioned a mixed public/private economy in which governments would provide basic infrastructure on a subsidized basis, and regulate markets to steer savings and new money or credit creation along productive lines. But Article 123 of the Lisbon Treaty assigns this role to commercial banks – including that of financing government budget deficits, by preventing central banks from lending to governments.

This constraint blocks governments from monetizing the spending needed to pull economies out of today’s post-2008 depression. It forces a shift from public money creation to commercial bank credit – and as noted above, this bank credit takes the form of irresponsibly inflating asset prices and distress lending. In this new “neoliberal” approach, the role of government is not to supply the economy with money, but to leave this to the banks – and then to act as debt guarantors even when the banks lend more than their debtors are able to pay.

Bank lobbyists defend this monetary handcuff by a scurrilous and historically false claim that public financing is inherently inflationary, even hyperinflationary. The implication is that commercial banks are more responsible than central banks, and that their credit creation on their own keyboards is less inflationary than when governments do this for social spending or infrastructure investment. Yet commercial banks have fueled the fastest and largest asset-price inflation in history! Loosening the terms of mortgage credit and even obtaining public guarantees for irresponsible lending – and in the United States, lobbying to decriminalize financial fraud, or at least to deregulate it and to insist on the appointment of law officials who refuse to prosecute – has obliged homebuyers to pay more for debt-leveraged housing, and investors to pay more for assets ranging from office buildings to stocks and bonds, thereby raising the price of buying a retirement income or, for pension funds, of paying a pension.

The aim of this financial game is to transfer the economic surplus into the hands of an emerging neo-oligarchy composed of bankers, bondholders and other creditors. Their strategy is to loan against real estate and corporate assets and income streams, while lobbying to make the tax code serve rentier interests by favoring rent-extraction rather than new investment. Speculation in asset-price gains receives tax preference over productive lending. Borrowers are able to pay back their loan with interest mainly by borrowing more against real estate, stocks or bonds whose price is being inflated by commercial bank credit creation.

Meanwhile, the economy at large loses as output and employment shrink – while prices for consumer goods and services rise. This is the post-crash austerity phase of the debt cycle. It is characterized by a transfer of property from debtors to creditors. So just as they received the income that was transmuted into interest payments on bank loans during the upswing, they foreclose on property during the downswing. The ensuing crisis becomes an opportunity for creditors to carve up public assets as well, in privatization programs dictated by the IMF, World Bank and EU bureaucracies acting on behalf of global creditors.

Under these conditions the major problem becomes one of how the economy is to avoid shrinkage, if debt service is withdrawing more revenue than the public sector deficit is providing to the private sector. Yet no government calculates this tradeoff between the withdrawal of income from production and consumption markets as compared to the fiscal deficit needed to restore the general purchasing power being drained. Financial interests deem any such body of analysis a potential attack and even “class war” by suggesting that their behavior is extractive rather than productive. Bank lobbyists prefer to popularize the myth that economies can get rich by increasing prices for real estate, stocks and bonds on credit faster than debt is growing – as if paying interest does not shrink the market for goods and services, and hence employment.

Failure to address these debt dynamics – the tendency of bank credit to inflate asset prices, and of interest to drain purchasing power from the economy – is a major reason why global investors as well as Greek and other voters have lost faith in the Eurozone. It has been hijacked by central planners drawn from the financial sector. They have shown themselves to be incompetent at best, and at worse deliberately misleading when they block central banks from creating money to lend to governments – by blaming the German hyperinflation on the Reichsbank printing money to spend domestically rather than on its attempt to pay foreign-currency debts abroad.

Collapsing the currency by trying to pay foreign creditors is what Third World countries were obliged to do for many decades under IMF tutelage. It is the fate that confronts Greece if there is no debt annulment and the country reverts to drachmas. This would make debts in euros or other foreign exchange more expensive to pay in domestic currency, raising import prices proportionally – regardless of the pace of domestic money creation or government deficits.

Why haven’t the past half-century’s productivity gains made everyone rich?

Today’s austerity is not the result of technology, diminishing returns or resource depletion. What prevents productivity gains from being translated into rising living standards is the financial sector attaching debt at an exponentially expanding rate to the economy’s assets and income streams. This turns land rent, resource rent, industrial profits, disposable personal income and tax revenue into a flow of interest to pay bankers and bondholders – whose lending bids up asset prices, so that buying a home, for example, requires going even deeper into debt.

The bankers’ business plan is to create credit up to the point where all “free” disposable revenue is pledged to pay interest. The aim is not to help economies grow or fund new capital formation. That is incidental to the aim of capitalizing rent, profit and disposable personal income into bank loans. The problem is that this is destructive of the economy at large, and hence of the banking system’s own viability. Financially siphoning-off of the surplus leads to foreclosures on property, including privatization of public enterprises and infrastructure on credit, enabling their purchasers to avoid paying taxes, thanks to the tax-deductibility of interest payments noted above. Hitherto free or subsidized services are to be saddled with rent-extracting tollbooths.

Not since the Middle Ages and colonization of the New World, Africa and Asia has the world seen so aggressive an economic warfare. The plan drawn up in 2011 for Greece to become a tribute-payer confronts voters with a condition for remaining part of the Eurozone that nobody expected a decade ago: replacing democracy with a rentier oligarchy administered by financial technocrats. The government is to serve bankers and bondholders by acting as their debt collector.

Today’s conquest thus is financial, not military. And what is so remarkable is that it is being waged in the ideological arena, as if it is all for the best! The illusion is that it paves the way for better growth involves expunging the memory of classical economics. Rentiers recognize that the greatest defense against their attack is to restore the classical distinction between earned and unearned income, and between productive and unproductive credit. These are the most effective analytic tools to guide the tax and financial reforms and balanced public/private economy envisioned in the Progressive Era to counter the special interests and their privatization grabs.

Bankers are the new central planners – and their plan is for austerity

When Greece, Italy and Spain joined the Eurozone, many voters hoped that in addition to the obvious aim of ending the many centuries of war, the European project would create a fairer economy by curing local political corruption and stopping the notoriously widespread tax evasion by the wealthy. I’ve heard Italians say that more active EU control should have saved them from Berlusconi, while in Spain the Basques hoped that pan-Europeanism would make their regional tensions with the national government a thing of the past.

Such optimism was not justified, because the EU constitution has no provision to clean up corruption or levy taxes efficiently– not even a uniform tax code. Even so, few voters anticipated that neoliberals would hijack EU governance to protect bankers from loss, at public expense with a deepening austerity being the “solution” to a decade of irresponsible bank loans.

Why should voters approve a European Union structured in such a way? If it cannot clean up local corruption and sponsor fair income and property taxation, and if it cannot create a central bank to help pull economies out of depression, then what is its appeal? What does a united Europe have to offer consumers or business if it subjects the continent to financial and fiscal austerity until entire countries look like Ireland?

Greece and other “southern rim” countries are not rejecting their European identity as such. They are rejecting austerity. The Eurozone is in danger of breaking up because it has come to mean central planning by bankers, or at least on their behalf. Neoliberals accuse government planning of being inefficient, but central planning by bankers threatens to resolve the present crisis by imposing depression. This is what the Eurozone has come to mean as the 1% at the top of the economic pyramid seek to increase their power over an increasingly indebted labor force, industry and government.

It seems inevitable that, continental Europe ultimately will shift its central bank policy to monetize budget deficits along the lines that Britain, the United States, Korea and other industrial economies have long been doing. But even so, it is not desirable to print money simply to finance budget deficits that stem from un-taxing land, monopolies, finance and other rent-seeking extractive activities. It also is unwise to create enough money to lend to the public to pay an insolvent debt overhead by borrowing more.

A model to be avoided is the U.S. Federal Reserve policy of taking junk mortgages from the banks onto its balance sheet – without writing down the debts of homeowners in negative equity. When government bailout funding exceeds the net worth of bank reserves, then the government has effectively become owner. The stockholders are wiped out, giving the government an opportunity to own and operate the financial system as a public option.

A Clean Slate: Thinking About the Unthinkable

Financial austerity can be avoided by cutting off its taproot: debts that have been created by (1) untaxing the “free lunch” economic rent from land, mineral resources and monopolies to capitalize it into bank loans, and (2) un-taxing inherited wealth, the highest income brackets and capital gains. “Freeing” rentier income from taxation has enabled the banks to capitalize it into larger loans to bid up property prices, while tax cuts have led to government deficits as large as military warfare used to cause. The resulting budget deficits are used as an opportunity for creditors to demand privatization of public infrastructure.

Restoring tax reliance on land and other rent-yielding assets – and restoring basic infrastructure to the public domain, or at least regulating its prices to bring them in line with technological necessary production costs – is made problematic by the fact that their rent already has been pledged to the banks as debt service. So classical free market policy today entails defaults, debt write-downs and deeper bank insolvency. The silver lining is that this situation opens the path to make the financial system a public utility as originally intended!

The benefits that Germany received from its 1947 Monetary Reform provide an object lesson. Allowing Germany to start free of debt enabled its industry to start without financial overhead, catalyzing its economic recovery – and serve as a bulwark against communism. It was easy for the Allies to annul German debts in 1947 because they were owed mainly to former Nazis. It is harder to cancel debts owed to today’s vested interests, especially to pension funds and popular savings. This is how deeply debt leveraging has become interwoven with the production-and-consumption economy to make a Clean Slate more politically radical today than it did a century ago.

All countries emerged from World War II with relatively little private-sector debt. Yet each recovery since that time has started from a higher level of debt. This has acted as a brake, making each new recovery weaker than the last – like trying to drive a car with the brake peddle pressed closer and tighter to the floor.

What makes debt cancellation politically problematic is that it entails writing off savings on the other side of the balance sheet. One party’s debt is another’s savings. Most to the point, the debts of the 99% are the savings of the 1% – and despite today’s democratic trimmings, the 1% control the government. Banks and other creditors are now much more strongly positioned to oppose writing down their claims on the non-financial economy. And they are willing to impose depression on Europe in order to collect in full. But they ultimately must lose as economies fall into depression. That is what is so self-destructive in their position. Bank reserves are wiped out when the debt overhead buckles and debts go unpaid.

This need not be a tragedy for society at large. Someone must bear the loss, and it is preferable for the financial sector to relinquish its enormous recent gains than for economy to grind to a halt. Economies can recover as banks re-open under public management in their same physical offices, while government leave insured depositors with minimum working balances.

Just as its Economic Miracle started with a debt cancellation, a viable Euro would best begin with a similar Clean Slate revive the economy today. As in 1947, the government could reimburse depositors for basic working balances. By making its economy as debt-free was the case after World War II, Europe can re-create the boom of seventy years ago. The role of a Clean Slate, after all, is to restore the normalcy of the status quo ante. It does not distort as much as reverse recent financial distortions. In this respect it is more conservative than radical.

A Clean Slate has the positive effect of wiping out the explosive debt leverage that has driven European governments, businesses, real estate and families into their present hole. “Deleveraging” – paying down a debt out of current income – would have a similar effect to Keynesian saving in the form of “hoarding”: It would prevent income from being spent on current output, thereby exacerbating debt deflation and depression. An organized write-down of debts is less disruptive than not canceling them. Despite the financial sector’s howls that wiping them out is destabilizing (a euphemism for making them take a loss on a financial system that was malstructured in the first place), the reality is that leaving these debts on the books is even more destabilizing – because the debt overhead simply cannot be paid. Trying to keep today’s public and private-sector debts on the books will cause even steeper, more drastic losses and economic polarization between creditors and debtors.

A European political realignment?

Banks repeat Margaret Thatcher’s censorial claim “There Is No Alternative” (TINA) to their business plan to attach debt to the entire surplus. The aim – and logical conclusion of the inexorable mathematics of compound interest – is for all corporate cash flow, real estate rent over break-even costs, and disposable personal income over basic subsistence to be paid as interest. Where these debts compound beyond the ability to be paid, the ECB, EU and IMF “troika” insist that that labor must reduce its consumption and give back the workplace rights and privileges has won over the past century. Consumers must be taxed more heavily, and public spending must be rolled back to squeeze out more fiscal surplus to pay the bankers and bondholders. In sum, Europe is to be subjected to the same kind of austerity that wrecked Latin American and other Third World debtors for so many lost decades.

This creation of feudal-type rentier privileges would roll back many centuries of reform. It is a financial version of the military grabs that seized the land and levied tribute a millennium ago.

There is an alternative, of course. Europe does not need to impoverish itself. It can create a real central bank and a “public option” in banking. It can renew the centuries of free market reforms to tax land and subsoil rights, natural monopolies and special privileges or return them to the public domain by de-privatization rather than leaving this rent extraction “free” to be capitalized into bank loans. Europe has put a financial tributary system in place and even has absorbed pension and popular savings into this system.

This financial warfare is engulfing Europe without most populations even realizing that it is being waged against them, and against industry as well. Most of all, financial interests seek to disable government, which is the only power strong enough to tax and check their power via public regulation and a central bank with a public option to provide basic monetary services.

To resist this attack, Europe’s political parties need to revive the path along which most were traveling before World War I. This requires re-introducing the history of classical economics into the academic curriculum to counter the censorship that neoliberal ideology has imposed on education and political discussion in the popular media.

A parallel neoliberal strategy has been to shunt religion along non-economic lines so as to prevent it from played the political role it did in past centuries, from the Schoolmen of the 13th century and Martin Luther ‘s denunciation of usury down to Christian socialism, Papal encyclicals, and of course Liberation Theology. Adam Smith was a professor of Moral Philosophy, and through much of the 19th century universities continued to teach economic thought as a branch of moral philosophy. The common key to this long tradition was to link ethical values to economics by value and price theory: the idea that people would earn income by providing a productive service to society, not by simply taking or by usury, rent-extraction or other unjust income.

The neoliberal challenge

By rejecting this value and price theory rentier advocates distort the historical focus of religion. Denying that any income is unearned or that economic rent and interest are transfer payments – defined as income not grounded in any necessary production cost – neoliberals replace classical moral philosophy with a pro-rentier caricature of science. Today’s National Income and Product Accounts omit “capital” gains from asset-price inflation, yet these account for most of the Bubble Economy’s buildup of wealth. My recent collection of essays, The Bubble and Beyond, reviews how economic theory has been turned into a set of tautologies.) Most seriously, the failure to perceive that the overall volume of debts cannot be paid – and indeed to put this at the very center of economic logic – is like denying global warming.

The term “neoliberalism” kidnaps the classical liberal idea of free markets that sought to erect defenses against special privilege and unearned income. To classical economists a free market meant one free of unearned income, defined as land rent, natural resource rent, monopoly rent and rent-extracting privilege. Neoliberals invert this idea. In their usage a free market is one free from taxes or regulation of such rentier income, giving such revenue (and capital gains) tax favoritism over wages and profits. Finance thus is free to operate unchecked as governments are treated as enemy, not protectors of the common weal.

By freeing markets from public regulation and taxation – that is, by dismantling checks and balances against exploitation and free lunches – neoliberalism becomes a doctrine of central planning. Control simply is shifted from governments to financial centers. The effect is to replace public power to protect the people with an oligarchic power to oppress them, disabling public authority to regulate and tax finance and its rent-extracting customers. To call this “freedom,” “free choice” or “free markets” is an exercise in Orwellian doublethink.

In these respects neoliberalism is a doctrine of power and autocracy, a weaponization of economic theory in today’s financial war against the economy at large. Its fiscal program is to un-tax banks and insurance companies, real estate and monopolies. The result is a financial war not only against labor but also – indeed, most of all – against industry and government, because that is where the money is. Gaining the power to indebt economies at increasing velocity, the banking and financial sector is siphoning resources away from the real economy. Its business plan is not to employ labor and expand output, but to transfer as much of the existing flow of revenue as possible into its own hands, by capitalizing it into interest payments.



Much as the Roman democracy arranged voting by “centuries” ranked by landed wealth, so in the United States votes are bought simply by dollars, mainly from the financial sector. The result must be economic polarization toward a rentier oligarchy. Much as Rome’s creditor class reduced the Empire to a Dark Age of subsistence and barter, today’s financial dynamics are globalizing the polarization between creditors and debtors, imposing austerity in the name of free markets. So as in Rome, the end stage of neoliberalism threatens to become debt peonage.

Finance capitalism vs. industrial capitalism

This is not the struggle that was forecast between capitalism and socialism. It is occurring within capitalism itself – between industry and finance. Finance capital has vanquished industrial capital. While social democracy has overcome the familiar class war between employers and workers, it has not been able to cope with the financial coup d’état against industry and labor alike. Capital goods used for productive purposes on the asset side of the balance sheet are the objective of finance capital extending loans on the liab9ilities side. Tangible capital has a cost (ultimately reducible to that of labor) and is limited in supply. Interest-bearing bank credit creation (“other peoples’ debt”) is potentially unlimited. It thus has become the paradigmatic free lunch.

What is limited is the ability to pay, and this is where industrial capitalism buckles under the demands of finance capital. Financial managers have taken over industry to bleed it, not to fund its expansion. Industrial firms have been financialized, turned into vehicles to pay interest and dividends or simply to spend their earnings on stock buybacks or to buy other firms rather than to undertake new capital investment. Companies even are borrowing to pay out loans as dividends so as to create quick stock-price run-ups – for their managers to cash in their stock options. This behavior has prompted industrial advocates to call banks locusts (Heuschrecke) devouring the surplus instead of acting like bees to fund tangible capital formation.

The path of least resistance to defend industry and rising living standards is to renew the Progressive Era social democratic program of turning banking into a public utility to provide basic financial services such as checking account and credit card transactions at cost or freely, like roads and other public services so as to minimize the price of living and doing business.

The basic principle that should guide public policy is age-old: recognition that any debt overhead tends to grow unpayably high. Over and above the exponential mathematics of compound interest is today’s “free” creation of credit (debt) emanating from the United States since the dollar’s link to gold was cut in 1971. The resulting expansion of debt tends to approach the point where it absorbs property rent, corporate cash flow and disposable personal income – along with a rising proportion of government revenue.

Industrial capitalism envisioned a circular flow between producers and consumers. That was the original concept of national income accounts created by Francois Quesnay and the Physiocrats. Today’s version treats finance, insurance and real estate (FIRE) as producing a “service” and hence as being part of this circular flow, not as an extractive transfer of income from it to an autonomous and increasingly predatory rentier class. National income is diverted to pay debt service, causing consumption and production to shrink as banks and financial institutions now play the role that landlords did in feudal and post-feudal times.

The resolution to today’s creditor claims must take the form either of bankruptcy and foreclosure, or a debt write-down. Over a quarter of U.S. real estate is now in negative equity, pending either forfeiture or even worse – a long fight by mortgage debtors just to reach the break-even point of zero net worth. This is the culmination of democratizing property ownership on credit. It is not economic freedom but debt peonage – having to spend a lifetime trying to work off debts in a situation forcing debtors deeper and deeper into a financial hole.

The need for debt writedowns to be widespread, extending to all personal debts – and hence restructuring the banking system – frightens many people from supporting so deeply structural an alternative. Yet it is much easier in practice to start afresh with a Clean Slate, as Germany did in 1947, than to retrofit a system that has been so crookedly designed. A review of history shows that such debt cancellations were normal practice from c. 2500 BC down to the time of Jesus. Rulers at the outset of civilization and commercial enterprise in the ancient Near East proclaimed Clean Slates to restore the status quo ante, a citizenry free from personal (barley) debts. (Commercial “silver” debts were left in place.) Babylonian andurarum edicts and kindred royal proclamations are found over a period of nearly three thousand years, and were the model for the Biblical Jubilee Year (deror). Rather than destabilizing economies, this practice preserved widespread property ownership, stable prices and liberty from debt bondage.

Neoliberalism denies that resolution of an unstable debt overhead must come from “outside” the financial marketplace. EU policy is turning “the market” into a straitjacket by shifting private-sector debts onto the government’s balance sheet while blocking governments from printing money to finance the resulting budget deficit. This inverts the direction of the last three centuries of economic and political reform. It is a political revolution – yet perhaps the most invisible and covert takeover in history. Banks are able to create a now-unlimited volume of credit, increasingly tax-free, and even receive public bailouts aimed at enabling them to resume lending to the non-financial economy. It is the equivalent of giving invaders land for free and turning over the tax system to conquerors – without a real fight or understanding just what is being given away.

The financial sector’s war against society at large has led to as deep a public debt as military warfare did in times past. The rentier tactic is to oblige governments to borrow from the wealthy at interest instead of taxing them, while indebting populations, real estate and industry by levying tribute in the form of interest and fees. To cap matters, banks demand subsidies and bailouts so that they will not suffer the when debts and savings expand beyond the ability to pay and hence must be wiped out. The financial sector’s ploy is to hold the economy hostage, threatening to stop the circulation of payments if they do not get their way.

Attacking government regulation and protection as leading down the “road to serfdom” toward centralized planning, the financial sector has become the great expropriator. It aims to centralize planning in Wall Street, the City of London, Frankfurt and other banking centers, steering entire national economies down the road to debt peonage. To achieve victory, high finance needs to disable government, which is the single power able to regulate, tax and otherwise curtail its expansion. To disable political democracy, finance buys control of the electoral campaigns so as to promote politicians acting as its officers. It also buys control of the television, radio and published mass media, and uses endowments to buy control of the academic process. Together, these are the various organs that represent the “brain” of society. They are being zombified today.

Religion itself has been diverted away from its age-long focus on debt and usury. Few Christians are taught that in his initial sermon, Jesus unrolled the scroll of Isaiah proclaiming the Jubilee Year, and said that this was his own task: to proclaim the “Year of the Lord” and announce a Clean Slate wiping out Jewish debts, liberating indebted bond-servants and restoring lands to their original pre-foreclosure owners. And the English-language edition of Martin Luther’s writings is careful to exclude his important pamphlet denouncing Cacus, the monster of exponentially self-expanding interest-bearing debt. Evangelicals in America are especially manic in defending financial claims on property, as if these claims are property itself, not its antithesis.

Neoliberals claim to protect the freedom of individuals, especially in the face of oppressive government, but not from creditors or rentiers. Classical economists realized that a strong government was needed to check the vested interests. Their aim was not to dismantle government, but to use its regulatory and taxing power in the public interest to minimize unearned income and “free lunches” – and to minimize the economy’s cost of living and doing business. By calling for “euthanasia of the rentier” through public policy, Keynes and his generation recognized that if governments are blocked from controlling and taxing Finance, Insurance and Real Estate (FIRE), the economy will pass into the control of financial planners.

There is no such thing as an “automatic” free market. Every successful economy has been a mixed economy, with the public and private sectors each having their distinct role. Privatization of money, credit, and other basic infrastructure services may be only a transitory phase of history, not the irreversible trend that neoliberals applaud and which has led to the present crisis of unchecked rentier power in a political vacuum.

Europe’s central bank tradition contrasted with Anglo-American merchant banking

In contrast to the Bank of England created to lend money to its government, which it has done most typically in time of war, continental European tradition has been for central banks to lend to commercial banks, which in turn hold their reserves largely in government bonds. So in effect, commercial banks monetize government deficits indirectly. Banks and bond buyers are supposed to act as responsible umpires, lending on economically viable terms that prevent inflation and irresponsible government spending. The German Constitution (Article 109 [2]) states the intention to foster price stability, employment, the balance of payments and economic growth.

This tradition is grounded in an epoch when most bank lending was to commerce and industry, and hence at least nominally productive. Europe prospered as long as its debt overhead was low enough to be carried. Since World War II, however – and especially over the past generation – the tsunami of credit created by U.S. and British banks has overwhelmed Europe’s industrial banking tradition. Banks have financed a real estate bubble (with the happy exception of Germany) and engaged in esoteric computer games. The upshot is that the continental European banking tradition that worked so well when grounded in industrial expansion has given way to an Anglo-American merchant bank practice, making gains simply by riding the wave of asset-price inflation – a self-feeding debt leverage ploy for banks to induce customers to borrow.

Today’s economic discussion should focus on what the best policy response should be in a situation where irresponsible credit is centered in commercial banks, not government spending. The pre-2008 asset-price bubble was not a result of central bank lending to governments. It was a product of favoritism toward the FIRE sector, facilitated by the Eurozone’s tax system focusing more on sales and income taxes than on land taxes aimed at leaving less “free” rental income to be capitalized into bank loans to bid up property prices to Bubble levels.

How should governments respond when reckless bank lending puts the entire economy at risk? This is what has happened most notoriously in the United States, Britain and Ireland with their junk mortgage (“subprime”) lending, liars’ loans and outright financial fraud fostered by a refusal to bring criminal charges against blatantly illegal activities. To put matters bluntly, the financial sector of English-speaking countries has been taken over by predators “free” to fill their pockets as quickly as possible. The current MF Global and Bank of America scandals are merely the most notorious unprosecuted financial crimes occurring today – and evidence of how their greed has corrupted government and the courts to block them from acting. Like ordinary criminals, the emperors of high finance do not care about the damage done by their raids.

The problem facing the Eurozone today is to decide just what should happen to Spain now that its real estate bubble has collapsed, leaving its reckless banks with negative equity. They are trying to hold the economy hostage, as if this corrosive financial debt creation somehow can – and should – be revived, as if it were normal – a status quo ante, not a wrong path. How much should Europe permit the banks fallen into negative equity to saddle national governments and “taxpayers” with their irresponsible loan losses?

In today’s downturn governments are called on to create public debt to give to commercial banks whose reserves have been lost as a result of bad lending – the bad financial behavior to which they have long accused governments of being prone! Should Eurozone governments surrender to bankers and take their bad real estate debt and the bonds of insolvent governments onto a pan-European public balance sheet. This would be an “oligarchization” (I hesitate to say socialization) of public debt – a transfer of wealth to the class that has been looting the economy.

This problem was not foreseen at the euro’s creation. Nor was it anticipated that governments would need to run budget deficits to pull Europe out of depression. Such spending necessarily is financed by public debt. Ironically, despite the recklessness of their commercial banking systems, central banks in the English-speaking countries are able to monetize public debt as freely as commercial banks can create credit on their own keyboards. This money-creating ability saves governments from being held hostage by creditors as a lever to force pro-rentier tax policies, privatization and deregulation. So the way out of the quagmire created by Anglo-Saxon commercial bank practice is shown by Anglo-Saxon practice when it comes to central banking.

Precisely because continental Europe’s more industrial and productive banking tradition limited the ECB to providing credit only to commercial banks to replenish bank credit in liquidity crises. It is blocked from lending to governments to monetize their budget deficits. This limited role leaves the ECB unable to cope with today’s solvency crisis. A debt-ridden economy cannot “grow” its way out of debt. And it certainly cannot “borrow its way out” by a U.S.-style Quantitative Easing program. The idea is that lower interest rates will enable the enormous debt overhead to be carried more easily – spurring new borrowers to buy out the old debtors. But this solution seeks merely to revive the bubble, by re-inflating asset prices to a level that will bail out the banks – by the economy at large running even more deeply into debt.

This means that business cannot borrow – especially the small and medium-sized firms responsible for most new employment in the U.S. and European economies over the last few decades. So the financial system has reached a terminus. Not only does most of the debt overhead need to be let go, but the banking and financial system (including financialized pension plans) and tax systems need to be restructured so as to prevent a recurrence of the Bubble Economy.

The debt overhead weighs as heavily on an economy as over-taxation. The only practical solution is a Clean Slate, and that is not something the ECB has authority to proclaim. Only a government body (or, in the European context, several governments acting in concert) can do this – under crisis conditions such as we are experiencing today. And if it fails to move with forethought along these lines, the debts will go down anyway, because debts that can’t be paid, won’t be. That is simple accounting.

Why is this kind of restructuring not at the center of today’s financial discussion – as if it is unthinkable? Not to think about alternatives means sitting by while Europe becomes an economic dead zone.

Statistical Appendix



These charts (click to enlarge) are reprinted with permission, copyright Eric Janszen at iTulip.com 2012. As he explains them:

The hyperinflation was not attended by a significant rise in bank notes in circulation. At the peak in the fall of 1924, notes in circulation at 2 billion at the peak of the hyperinflation were less than a third of the wartime peak. The hyperinflation ended with the cancellation of the paper mark and start of the Reichsmark Jan. 1925 starting with the conversion of all 2 billion paper marks to Reichsmark. Notes in circulation of the new land-backed Reichsmark continued to rise to near 6 billion mark wartime levels over the next five years as inflation remained below 2%. … Rather than notes in circulation, it can be said that the deflation that occurred before the hyperinflation was in fact a result of a collapse in the money supply, but that the 1924 hyperinflation that followed can be seen to result from a collapse of the exchange rate value of the paper mark starting in 1923. ,,, the title “Ka-Poom” on the charts refers to a “Ka-Poom Theory” that I have developed over the past 12 years about how a nation with excessive foreign liabilities eventually defaults via inflation, should it have a political falling out with its creditors, or should its creditors suffer severe domestic problems of their own that override the imperative to rescue the debtor. The pattern repeats in every case in varying time periods and degrees of severity, as in Russia in the early 1990s or Argentina in the early 1990s and again in the early 2000s.

Footnotes

I describe the reparations and Inter-Ally arms-debt tangle in Super Imperialism (new ed. 2003), and the distinction between the domestic “budget problem” and the international “

George Soros, Remarks at the Festival of Economics, Trento Italy, June 2, 2012