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Michael Hudson was recently interviewed for our 200th show, following his visit to President Medvedev’s Global Policy Forum. The interview has gone viral following a link from Naked Capitalism and Michael’s popular site.
Karl Fitzgerald: Michael Hudson, our old friend here on the Renegade Economists, from the University of Missouri in Kansas City, has just returned from Russia speaking at the Global Policy Forum. Michael, tell us about the GPF.
MH: well that’s organized by President Medvedev more or less as an anti-Davos. Whereas the Davos invites many of the financial people to figure out how to run the West further into debt the subject of this forum was Russian poverty and how to overcome the fact that in the last 20 years the neo-liberal program that promised that Russia and the rest of the soviet republics would get rich has simply driven them all into debt and impoverished them.
KF: And so 30 years on from glasnost there must be quite some sense of concern about where the Russian economy has ended up.
MH: there certainly is. It’s been losing not only capital flight of $25 billion a year to the west but its people have been emigrating and President Putin, now Prime Minister Putin, has said that the demographic effect of just privatizing Russian real estate, and industry and following western advice has lost maybe 30 million Russians from what the normal demographic growth would be to 2050. So the effect of neo-liberal financial policy has been more devastating to Russia than WW2.
KF: 30 million people have gone due to neo-liberal policies?
MH: that’s right. The birth rate has fallen, life spans are shortening, and this is throughout the former Soviet Union. People of working age are emigrating. Instead of getting rid of the old Stalinist bureaucracy the neo-liberals simply privatized it and the result of course is corruption. Now public officials that used to be in charge of handing out public policies and administering them- not very efficiently its true – simply say give us a bribe or we won’t work.
In Latvia, for instance, people who go to doctors are expected to pay the doctors under the table in a little white envelope…but most notorious of all is the real estate debt they’ve taken on. What’s unique is that, just imagine, 20 years ago when there was the revolution that turned over power to Yeltsin in Russia and broke up the Soviet Union there wasn’t any debt at all. Families had all been living in their homes without paying rent and getting a free public education, public services were free and employers provided lunch, vacations and pensions, cultural and all of these connections were pulled up. And all of a sudden instead of just turning over the property to the people who lived in the homes and the businesses that used the offices the government said, okay, we are going to put it all up for sale and let the banks, usually the foreign banks, lend you the money, to buy it.
And the result was the biggest real estate bubble in the world in the mid 90’s and this is what started the whole real estate bubble- certainly what catalyzed it in the west because all of a sudden Russians, Latvians, Estonians and other people had to take on a lifetime of debt in order to get the homes that they’d been living in and not be thrown out on the street. So essentially they were told your money or your life – that’s neo- liberalism.
KF: And they’ve turned over from quite a stable society to one based on volatility, and oil price volatility. The after effects of the 2008 meltdown must have shocked a lot of people in the Russian government. What was the talk along those lines – what were people thinking about?
MH: Very little because they’d already in 1991 dismantled their industry. They were told that the way to get rich was to become a raw materials exporter or what the American protectionists and the bible called “hewers of wood and drawers of water”. So Russia simply dismantled its industry. The west said, oh, you’re not competitive and what the Russians didn’t realize is that all of this was very self serving to the west. The West, especially the American planners- the Harvard boys that went over said, well, we really don’t want is for Russia ever to be a military threat. We’d like to conquer it, to break it up, let’s now just slam them at the end of the cold war.
So without an industrial, manufacturing base there can’t really be much of a military. So the first thing they did was say – get rid of your manufacturing, get rid of your engineering, begin charging for your schooling, close down the schools – you don’t need engineers all you really need to do is make a hole in the ground.
But none of this export revenue from the hole in the ground should really be turned over to the state – we want to make sure that you only tax labor and tax business, but don’t tax natural resources – let it all be privatized. And so Russia thought, gee this sounds like a funny way to get rich but that’s what they did. And so they followed the Harvard advice to give away the oil, the nickel companies, the mineral resources, and that’s how they got the money to begin sending it all to the west. There wasn’t any Russian money to buy these companies because the IMF and World Bank wiped out Russian savers with a hyper inflation by getting rid of all the capital controls and letting the rouble float. So it was just one bad advice after another and now the Russians realize they’ve been taken.
And they’re trying to figure out how on earth do we get out of this mess following the West’s advice. They thought, and the Baltics thought, that they were been told how to develop in the way that the West did. Neo-liberalism is the exact opposite of how Britain and the United States, Germany, Japan, and now China, got rich by progressive taxation, and having public infrastructure provided at much lower cost than privatized infrastructure and a resource fund tax, basically a land tax which is how Europe and America – states and localities – have been financed all throughout their history.
KF: So what was the sentiment at this GPF? Was there much discussion along those lines or are they tinkering at the edges with Tobin taxes and the like?
MH: Mostly tinkering at the edges. For instance Paul Krugman was invited and most of the focus was on the US and western financial meltdown. And he pointed out that while the problem of the post 2008 bubble was caused by private sector banking -the financial bubble – the solution is focusing on fiscal policy and particularly cutbacks in social security, Medicare and social spending and so the government’s response to the crisis that the banks have caused is to reduce living standards for labor all the more by taxing labor. There was no discussion by the Americans or by anybody that there was another fiscal policy that would have prevented the bubble in the first place, namely taxing the land and taxing real estate, and having a resource rent tax that wouldn’t have left all of this free lunch income available to be pledged to the banks and paid out as interest.
KF: I just can’t understand this austerity mentality that’s going on. Have Western economies lost the understanding of the multiplier effect? Can you explain to us what the multiplier effect is and why it’s no longer relevant under today’s neo liberal agenda?
MH: The basic idea is that if there is a decline in purchasing power – what we’re in right now in the West is debt deflation – people have to pay so much more money every month to pay their mortgage debt, their bank debt, their education loans and other bank loans, that they don’t have enough money to spend on goods and services. Now without spending on what labor produces – the goods and services – the businesses are not going to employ more labor to produce goods and services and they’re not going to invest in capital.
So the idea is if there’s a shortfall in the demand for goods and services the government should step in and run a budget deficit to rebuild the infrastructure because that’s what governments have always provided – roads and everything – in order to keep the economy solvent. But the bankers and the neo-liberals don’t want this.
When you have a poverty imposed on a country decade after decade, somebody is benefiting from all this and people are saying isn’t it too bad that economies are getting poor. Well it’s not too bad at all if you’re a banker because now these countries like Greece and Ireland are broke and now the bankers get to go to them and say, well, you have to finance your government spending not by government running a deficit – but sell us your real estate, sell us your mines.
So the bankers of the European central bank have gone to Greece and said in order for us not to plunge you into anarchy and just destroy your banking system you have to sell us your prime tourist land, ports, water and sewer systems so we can begin to charge people for water and sewers – you have to sell us your roads so that we can put up toll booths, but most of all give us your land, give us the Parthenon and if you don’t we will wreck your economy.
So what most people think is a policy mistake isn’t a mistake at all by the bankers. This is where they say foreclosure time has arrived and we’re going to get rich. This is where we put on the squeeze and the effect of finance under these conditions is very much like a military invasion but it’s a military attack without anybody losing their life except for the people who commit suicide, who die early and emigrate for the whole thing. So people don’t realize that the poverty for the many and the austerity is how the wealthy 1% of the population gets to clean up.
KF: surely though in Russia they’ve seen these huge property bubbles in Moscow, they’ve seen the oligarchs fly around the world buying up soccer teams all over the place and on the other side they’ve got their lead ice hockey team die in a plane crash and the average person on the street is not even surprised that planes fall out of the sky like anybody’s business over there. So how much can the people in Russia handle before they get really serious about looking at deep seated economic reform?
MH: nobody knows. There are the oligarchs and while Russia is known for the fact that much of the population is in poverty the fact is that they’ve created an awful lot of billionaires, almost more than anywhere else by giving them all of the land, resources, oil and the gas. So all the billionaires do what they do in other countries. They pretty much control the government and they’ve convinced the government to stop providing schooling and to close down many of the schools, especially in engineering, and they control the media so people really aren’t discussing the kind of thing that we’re discussing here.
That came out pretty clearly. The head of the economics section of the Academy of Sciences did ask me to write up most of these ideas to put them into discussion but the discussion has been almost entirely censored by the neo-liberal advisers who they brought over, ever since Jeffrey Sachs and the Harvard boys all came over and said don’t follow any advice but ours – there was a choice and they don’t realize in Russia that there was a choice.
For instance in 1991 my friend Ted Gwartney went over to St Petersburg in Moscow and offered to make a land map for them and said, look, if you make a land map and the price of real estate goes up, if the rental value of these homes goes up this should be your tax base and you’ll have the money to continue to spend on infrastructure – you won’t have to tax your labor and you can make your industry into a world competitive force.
Well he was told by the World Bank that’s not our plan. Our plan is to have a flat tax – to tax labor, not to tax land and resources because we want the West to buy up these resources. We want to buy it all and we don’t want to be taxed. We want the Russians to pay the tax and then we want all of their skilled labor to go to the West and that will cripple them. Russia’s poverty is the West’s benefit in this case and the result was that Russia became the world’s leading stock market from 1994 to 1997 and made enormous fortunes for Wall Street speculators while essentially emptying out Russian capital, labor, industry and the same thing happened in the Baltics.
KF: and now we have David Cameron in Russia spruiking up the support for Russia to join the WTO.
MH: I can’t understand that. Nobody discussed that in policy. We just talked about how Russia could overcome the poverty that it’s in and what they could do.
KF: so it’s interesting what’s happening on the world trade frontier we’re seeing this new age of protectionism becoming more and more prevalent with currency devaluation and recently the Swiss franc had a cap placed on it. Of course the Chinese Reminibi has always been undervalued there to assist their exports. What you are seeing now that America has all sorts of public-private contracts written in where there’s local procurement policies in place where you to buy a certain amount of steel from a local manufacturer for example.
MF: that’s been the case for the last 100 years. America has always been the most protectionist country in the world. This is where the theory of protectionism was really refined in the second half of the 19th century and when the WTO and international trade agreements – the GATT- were being formed after WW2 the US grandfathered in its protectionism. It said we’re going to have free trade except for countries that already have agricultural price supports and other subsidies – they get to continue what they’re doing and so America has always been the most protectionist country in the world and that’s what I wrote about in (my books) “Global Fracture” and “Super Imperialism”.
KF: Well so many countries are looking to protect their own backyard because of the short electoral cycle, because of the failure of these neo-liberal policies to deliver the so called wealth bonus for everyone and now the story keeps growing – let’s blame the banks for it was all to do with their corrupt lendings. Well I was very interested the other week to see the FHFA lawsuits against 17 banks in America been launched, and it was stated that Goldman Sachs were employing property valuers or appraisers who would overstate the value of the land that they were lending against and I was just wondering – you say you worked with a few land valuers, Ted Gwartney you mentioned – how they have been incorporated into this giant bubble ponzi scheme we are stuck within?
MH: the financial sector in America basically has become a criminalized sector. My colleague at the University of Missouri, Kansas City, Professor Bill Black, calls it a crimino-genic environment. He was one of the heads of the Federal Savings and Loans Bank board back in the 1980’s when the Savings and Loans were going bust on crooked loans to real estate and he points out at that time 2000 executives were sent to jail for financial fraud. In this bubble nobody has been sent to jail not even the big perpetrators such as Angelo Mizzello of Countrywide and the reason is that the banks bought immunity from politics by backing politicians who agreed not to regulate – not to do anything about the financial fraud that the FBI itself warned about. Basically you’re going to have criminals going to where all the money is – you know – where the wealth is.
The economy’s richest sector isn’t industry – it’s actually real estate – and the largest element of real estate is land. So most of the criminals all said here’s where all the money is, here’s where we can get rich in real estate lending. So in America they had no documentation loans so in other words the banks said we have got to begin … here’s this huge market and we make money making loans – let’s fuel a real estate bubble. They fueled it by easier and easier loan terms.
In the past in America a local bank would make a loan to somebody they knew – families that put 30% down and they would pay off with their income and the bank would use this income to pay part of it out as interest to depositors. Well in the last 15 to 20 years banks have begun to package them and sell them to other people. So the crookedness and the fraud took place in having mortgages way above the property value at a very high interest rate and then selling them to pension funds, to German banks, and to foreigners and essentially selling them property for much more than it was actually worth.
For instance the FBI found that 80% of the mortgage loans in these packages were fraudulent and in the worst of the liar’s loans – the AAA rated packages- the average actual price of the property in America happened to be the same value as in Ireland – 22 cents on the dollar. In other words 4/5 of these loans were just way beyond the value. Well that’s why all of a sudden, now that the banks are no longer fueling property by credit – and they’ve withdrawn their loans – that’s why property prices have fallen by about 30% in America and you walk down the street and there are “For Sale” signs everywhere and there are empty shops in the big shopping streets.
KF: so I just want to get this straight. Are you saying that it’s the packaging up of mortgages and on-selling them in these exploding interest type mortgages was that what caused the great recession that we are in now in or was there a deeper part?
MH: well the deeper cause is the fact there was a real estate bubble to begin with and the reason people wanted to take out mortgages now was that they thought that we had better buy a home now before the price rises even further and they didn’t realize that the reason prices were rising were because the banks were making easier and easier credit. They thought that homes were worth what the rental value was or what people could afford to pay when actually what a home is worth is whatever a bank is going to lend against it. So if somebody goes out to buy a home they’re bidding against other people for the same house and the winner is the person who can get the biggest bank loan and that’s the person who says I’m going to pledge all the rental value to the bank so the bank gets all the rent as if it were the landlord.
So three years ago, for the first time in American history, the average home equity relative to bank loan fell below 50%. And now, just 3 years later, for the USA as a whole, homeowners own only 1/3 of their home, 2/3 are owned by the banks and that it is despite the fact that about 20% of homes are owned without any mortgage at all- free and clear.
It’s basically a financial bubble that is based on what the banks can squeeze out of people who are trying to buy houses on credit and the price of credit – the debt service – absorbs all of the rental value. So in the past people used to criticize landlords for squeezing workers living standards but now that you’ve democratized land ownership it’s the banks that are doing the squeezing. But obviously there has to be the rental value there and in America about 40% of a blue collar worker’s income goes to pay for housing. Now that’s an enormous percentage. You don’t have a bank bubble in Germany so that there you only have 20% of income going to pay labor. So you talked about protectionism and trade earlier and people think, gee. German labor must be highly productive so that it can afford to undersell everyone else although the reality is that German labor doesn’t have to pay as much of a mortgage as American labor so of course Germany can undersell Americans using the same technology.
KF: what I’m trying to get at though is because the tax system penalizes us for working and rewards speculation in property, surely, that has given the big heads up to the powers that be to invest in real estate, to speculate, in that area and that’s what has forced the land prices up so high that its forced all these people to become sub-prime mortgagees – you know they wouldn’t have had that home credit stress if the price of land was lower due to the tax system but you’re saying, listen, that its only due to what the banks can lend. Isn’t that secondary?
MH: now wait a minute – there’s a connection between the two. By not taxing land the government has left all of this rental value free to be pledged to the banks. People think that land tax actually increases the overall burden of homeowners and workers but its just the opposite. If this rental value that’s been pledged to the banks as mortgage interest were taxed then the banks wouldn’t be able to capitalize the rent into a large mortgage loan. Housing prices would be much lower if we had the old fashion land tax like we used to have and also by taxing the land you wouldn’t have to have all of these heavy taxes that are put on labor. For instance in Latvia in 2 weeks they’re having a national election. In Latvia there’s a set of flat taxes on employment that add up to 59% of the wage budget and there’s only a 1% tax on the value of property. So here you have money going into real estate which is untaxed – people will borrow against it – and instead of the government getting this rental value which is created by nature and by the community building roads and infrastructure the banks get it and the government has turn to somewhere else to tax – namely on to employment.
KF: I’m pleased you clarified that Michael because a lot of people blame the 70’s recession and stagflation period on the oil bubble but few remember there was a monstrous land price bubble that happened back then. I’m seeing that this era we’re going through now, we’re going to blame the wrong thing – we’re going to say listen it was the banks and all of their dodgy lending strategies that caused this whereas really to look right at the root cause it would be fairer to say, look, it’s the land problem and we’ve got to tax the right things.
MH: the banks lending strategies are part and parcel of fiscal policy. Financial reform and fiscal reform are two sides of the same coin because banks lend against whatever the tax collector doesn’t collect. If you don’t tax a free lunch then it gets pledged to the banks just like when the Russians gave away their oil and gas, the kleptocrats borrowed, mainly from the west, to buy these things, so that the government didn’t get the revenue. There’s a tradeoff between either taxes or interest but one way or another somebody’s going to pay the rental value of the mines, of homes, and of office buildings – of all of these things – so the whole economy is turned from a real estate toll booth into a financial toll booth.
KF: so essentially you’re seeing that the world economy is going to splutter along for another 5 or so years in this recessionary mode with everyone on the edge of our seats worrying about share markets?
MH: it will continue to shrink. Nobody can see how industrial profits can grow if they’re not able to sell. In America 40% of recorded corporate profits are made by the banks. Now when that happens – these are not factories, these are not employment figures – I think the Bank of America said yesterday that it’s firing 30,000 people – the banks are downsizing because the economy is all loaned up – there’s no one else they’re going to make loans to. The economy is shrinking steadily, I think, over the next 5 years, and it will continue to shrink as far as the eye can see until people write down the debts and change the tax policy.
Additional ‘un-published’ commentary:
KF: Michael Hudson – fantastic to have you on the show. On a finishing note, 1/3 of Australia’s corporate profits just announced this profit reporting season were from the mining sector.
MH: uh ha – well that means that all of these profits could have been taken by the government which used to own all the sub-soil wealth and that means that money that used to be paid in taxes, so that they wouldn’t have to tax employment, instead is been paid out to the financial sector and in fact when I met with the central bankers down in Australia in 2009 they said Australia doesn’t need any industry, it doesn’t even need employment, all it really needs is to make money off the mines’ mineral exports – to make holes in the ground. So I’m not sure what the Australian’s are hoping to get out of all this.
KF: yeah well we’re just a giant quarry, a quarry economy that seems to be what’s happening around the world and quite interesting to see that in Brazil that they’re talking about a 4% royalty on iron ore rates – just 4% – and of course the ‘poor’ miners there are screaming about it. You beat your head against a wall wondering how much easy money these guys have to make before they realize how some of this commonwealth should be paid back to the government.
MH: well that’s what we call wealth addiction. Their demands are infinite and they are willing to sacrifice billions of dollars in the economy just to make 10 or 20 dollars more for themselves. That’s the financial mentality.
KF: Michael I hear you’ve been writing a book. What topics are you covering?
MH: well I’m putting together most of my economic essays and the economic model that has described all of this. I’m explaining that there are two approaches to the economy. One is the sort of neo-liberal free trade approach that’s taught almost censorialy today in the text books and the other is the classical economics approach that made a distinction between earned income and unearned income, between the rentiers getting a free lunch and the industrial economy. And I’ve been publishing this for about 20 years. So I’m putting it all into more or less a history of economic thought and application to today’s bubble economy to explain it all.
KF: fantastic Michael – we’ll keep an eye on michael-hudson.com for more on that.