The Toll Booth Economy
By MICHAEL HUDSON
It looks like bookstores are about to be swamped this summer and fall by advisories which publishers commissioned a year ago, as the economy was going off the rails. The preferred marketing strategy is to offer advice by celebrity insiders on how to restore the happy 1981-2007 era of debt-leveraged price gains for real estate, stocks and bonds. But the Bubble Economy was so debt-leveraged that it cannot reasonably be restored.
For the time being we are being fed Wall Street defenses of the Bush-Obama (that is, Paulson-Geithner) attempt to re-inflate the bubble by a bailout giveaway that has tripled America’s national debt in the hope of getting bank credit (that is, more debt) growing again. The problem is that debt leveraging is what caused our economic collapse. A third of U.S. real estate is now estimated to be in negative equity, with foreclosure rates still rising.
In the face of this stultifying financial trend, the book-buying public is being fed appetizers pretending that economic recovery simply requires more “incentives” (special tax breaks for the rich) to encourage more “saving,” as if savings automatically finance new capital investment and hiring rather than what really happens: money lent out to create yet more debt owed by the bottom 90 percent to the economy’s top 10 percent.
After blaming Alan Greenspan for playing the role of “useful idiot” by promoting deregulation and blocking prosecution of financial fraud, most writers trot out the approved panaceas: federal regulation of derivatives (or even banning them altogether), a Tobin tax on securities transactions, closure of offshore banking centers and ending their tax-avoidance stratagems. No one presumes to go to the root of the financial problem by removing the general tax deductibility of interest that has subsidized debt leveraging, by taxing “capital” gains at the same rate as wages and profits, or by closing the notorious tax loopholes for the finance, insurance and real estate (FIRE) sectors.
Right-wing publishers recycycle the usual panaceas such as giving more tax incentives to “savers” (another euphemism for more giveaways to high finance) and a re-balanced federal budget to avoid “crowding out” private finance. Wall Street’s dream is to privatize Social Security to create yet a new bubble. Fortunately, such proposals failed during the Republican-controlled Bush administration as a result of a reality check in the form of taxpayer outrage after the dot.com bubble burst in 2000.
There’s no call to finance Social Security and Medicare out of the general budget instead of keeping their funding as a special regressive tax on labor and its employers, available for plunder by Congress to finance tax cuts for the upper wealth brackets. Yet how can America achieve industrial competitiveness in global markets with this pre-saving retirement tax and privatized health insurance, debt-leveraged housing costs and related personal and corporate debt overhead? The rest of the world provides much lower-cost housing, health care and related costs of employee budgets – or simply keeps labor near subsistence levels. This is a major problem with today’s dreams of a renewed Bubble Economy. They leave out the international dimension.
And of course there are the familiar calls to rebuild America’s depleted infrastructure. Alas, Wall Street plans to do this Tony Blair-style, by public-private partnerships that incorporate enormous flows of interest payments into the price structure while providing underwriting and management fees to Wall Street. Falling employment and property prices have squeezed public finances so that new infrastructure investment will take the form of installing privatized tollbooths over the economy’s most critical access points such as roads and other hitherto public transportation, communications and clean water.
There are no calls to restore state and local property taxes to their Progressive Era levels so as to collect the “free lunch” of land rent and use its gains over time as the main fiscal base. This would hold down land prices (and hence, mortgage debt) by preventing rising location values from being capitalized and paid out as interest to the banks. It would have the additional advantage of shifting the fiscal burden off income and sales (a policy that raises the price of labor, goods and services). Instead, most reforms today call for further cutting property taxes to promote more “wealth creation” in the form of higher debt-leveraged property price inflation. The idea is to leave more rental income to be capitalized into yet larger mortgages and paid out as interest to the financial sector. Instead of housing prices falling and income and sales taxes being reduced, rising site values merely will be paid to the banks, not to the local tax authorities. The latter are forced to shift the fiscal burden onto consumers and business.
There are, in this current crop of books, the usual pro forma calls to re-industrialize America, but not to address the financial debt dynamic that has undercut industrial capitalism in this country and abroad. How will these timid “reforms” look in retrospect a decade from now? The Bush-Obama bailout pretends that banks “too-big-to-fail” only face a liquidity problem, not a bad debt problem in the face of the economy’s widening inability to pay. The reason why past bubbles cannot be restored is that they have reached their debt limit, not only domestically, but also the international political limit of global Dollar Hegemony.
What don’t these books address? Everything economics really is all about: the debt overhead; financial fraud and crime in general (one of the economy’s highest-paying sectors); military spending (a key to the U.S. balance-of-payments deficit and hence to the buildup of central bank dollar reserves throughout the world); the proliferation of unearned income and insider political dealing. These are the core phenomena that “free market” choristers have relegated to the “institutionalist” basement of the academic economics curriculum.
For example, the press keeps on parroting the Washington line that Asians “save” too much, causing them to lend their money to America. But the “Asians” saving these dollars are the central banks. Individuals and companies save in yuan and yen, not dollars. It is not these domestic savings that China and Japan have placed in U.S. Treasury securities to the tune of $3 trillion. It is America’s own spending – the trillions of dollars its payments deficit is pumping abroad, in excess of foreign demand for U.S. exports and purchases of U.S. companies, stocks and real estate. This payments deficit is not the result of U.S. consumers maxing out on their credit cards. What is being downplayed is the military spending that has underlain the U.S. balance-of-payments deficit ever since the Korean War. It is a trend that cannot continue much longer, now that foreign countries are starting to push back.
Inasmuch as China’s central bank is now the largest holder of U.S. government and other dollar securities, it has become the main subsidizer of the U.S. payments deficit – and also the domestic U.S. federal budget deficit. Half of the federal budget’s discretionary spending is military in character. This places China in the uncomfortable position of being the largest financier of U.S. military adventurism, including U.S. attempts to encircle China and Russia militarily to block their development as rivals over the past fifty years. That is not what China intended, but it is the effect of global dollar hegemony.
Another trend that cannot continue is “the miracle of compound interest.” It is called a “miracle” because it seems too good to be true, and it is – it cannot really go on for long. Heavily leveraged debts go bad in the end, because they accrue interest charges faster than the economy’s ability to pay. Basing national policy on dreams of paying the interest by borrowing money against steadily inflated asset prices has been a nightmare for homebuyers and consumers, as well as for companies targeted by financial raiders who use debt leverage to strip assets for themselves. This policy is now being applied to public infrastructure into the hands of absentee owners, who will build interest charges into the new service prices they charge, and be allowed to treat these charges as a tax-deductible expense. Banking lobbyists have shaped the tax system in a way that steers new absentee investment into debt rather than equity financing.
The cheerleaders applauding a bubble economy as “wealth creation” (to use one of Alan Greenspan’s favorite phrases) would like us, their audience, to believe that they knew that there was a problem all along, but simply could not restrain the economy’s “irrational exuberance” and “animal spirits.” The idea is to blame the victims – homeowners forced into debt to afford access to housing, pension-fund savers forced to consign their wage set-asides to money managers for the large Wall Street firms, and companies seeking to stave off corporate raiders by taking “poison pills” in the form of debts large enough to block their being taken over. One looks in vain for an honest acknowledgement of how the financial sector turned into a Mafia-style gang more akin to post-Soviet kleptocrat insiders than to Schumpeterian innovators.
The post-bubble tomes assumes that we have reached “the end of history” as far as big problems are concerned. What is missing is a critique of the big picture – how Wall Street has financialized the public domain to inaugurate a neo-feudal tollbooth economy while privatizing the government itself, headed by the Treasury and Federal Reserve. Left untouched is the story how industrial capitalism has succumbed to an insatiable and unsustainable finance capitalism, whose newest “final stage” seems to be a zero-sum game of casino capitalism based on derivative swaps and kindred hedge fund gambling innovations.
What have been lost are the Progressive Era’s two great reforms. First, minimizing the economy’s free lunch of unearned income (e.g., monopolistic privilege and privatization of the public domain in contrast to one’s own labor and enterprise) by taxing absentee property rent and asset-price (“capital”) gains, by keeping natural monopolies in the public domain, and by anti-trust regulation. The aim of progressive economic justice was to prevent exploitation – e.g., charging more than the technologically necessary costs of production and reasonable profits warranted. This aim had a fortuitous byproduct that made the Progressive Era reforms seem likely to conquer the world in a Darwinian evolutionary manner: Minimization of the free lunch of unearned income enabled economies such as the United States to out-compete others that didn’t enact progressive fiscal and financial policy.
A second Progressive Era aim was to steer the financial sector so as to fund capital formation. Industrial credit was best achieved in Germany and Central Europe in the decades prior to World War I. But the Allied victory led to the dominance of Anglo-American banking practice, based on loans against property or income streams already in place. Today’s bank credit has become decoupled from capital formation, taking the form mainly of mortgage credit (80 per cent), and loans secured by corporate stock (for mergers, acquisitions and corporate raids) as well as for speculation. The effect is to spur asset-price inflation on credit, in ways that benefit the few at the expense of the economy at large.
The problem of debt-leveraged asset-price inflation is clearest in the post-Soviet “Baltic syndrome,” to which Britain’s economy is now succumbing. Debts are run up in foreign currency (real estate mortgages in the Baltics, tax-avoidance funds and flight capital in Britain), without exports having any prospect of covering their carrying charges, as far as the eye can see. The result is a debt trap – chronic austerity for the domestic market, causing lower capital investment and living standards, without hope of recovery.
These problems illustrate the extent to which the world economy as a whole has pursued the wrong course since World War I. This long detour has been facilitated by the failure of socialism to provide a viable alternative. Although Russia’s bureaucratic Stalinism got rid of the post-feudal free lunch of land rent, monopoly rent, interest and financial or property-price gains, its bureaucratic overhead overpowered the economy in the end. Russia fell. The question is whether the Anglo-American brand of finance capitalism will follow suit from its own internal contradictions.
The flaws in the U.S. economy so intractable, embedded as they are in the very core of post-feudal Western economies. This is what Greek tragedy is about: a tragic flaw that dooms the hero. The main flaw embedded in our own economy is rising debt in excess of the ability to pay is part of a larger flaw: the financial free lunch that property and financial claims extract in excess of a corresponding cost as measured in labor effort or an equitably shared tax burden (the classical theory of economic rent). Like land seizure and insider privatization deals, such wealth increasingly can be inherited, stolen or obtained by political corruption. Wealth and revenue extracted via today’s finance capitalism avoids taxation, thereby receiving an actual fiscal subsidy as compared to tangible industrial investment and operating profit. Yet academics and the popular media treat these core flaws as “exogenous,” that is, outside the realm of economics analysis.
Unfortunately for us – and for reformers trying to rescue our post-bubble economy – the history of economic thought has been rewritten in infantile caricature, to give an impression that today’s stripped-down, largely trivialized junk economics is the apex of Western social history. One would not realize from the present discussion that for the past few centuries a different canon of logic existed. Classical economists distinguished between earned income (wages and profits) and unearned income (land rent, monopoly rent and interest). The effect was to distinguish between wealth earned through capital and enterprise that reflects labor effort, and unearned wealth stemming from appropriation of land and other natural resources, monopoly privileges (including banking and money management) and inflationary asset-price “capital” gains. But even the Progressive Era did not go much beyond seeking to purify industrial capitalism from the carry-overs of feudalism: land rent and monopoly rent stemming from military conquest, and financial exploitation by banks and (in America) Wall Street as the “mother of trusts.”
What makes the latest bubble different from previous ones is that instead of being organized by governments as a stratagem to dispose of their public debt by creating or privatizing monopolies to sell off for payment in government bonds, the United States and other nations today are going deeply into debt simply to pay bankers for bad loans. The economy is being sacrificed to reward finance, instead of finance subordinating and channeling finance to promote economic growth and lower the economy-wide cost structure to remain viable. Interest-bearing debt is weighing down the economy and causing debt deflation by diverting saving into debt payments instead of capital investment. Under this condition “saving” is not the solution to today’s economic shrinkage; it is part of the problem. In contrast to the personal hoarding of Keynes’s day, the problem is the financial sector’s extractive power as creditor instead of clearing the slate by wiping out the economy’s bad-debt overhang in the historically normal way, by a wave of bankruptcy.
Today, the financial sector is translating its affluence (at taxpayer expense), into the political power to pry yet more public infrastructure away from state and local communities and from the public domain at the national level, Thatcher- and Blair-style as it is sold off to absentee buyers-on-credit to pay off public debt (while cutting taxes on wealth yet further). No one remembers the cry for what Keynes called “euthanasia of the rentier.” We have entered the most oppressive rentier epoch since feudal European times. Instead of providing basic infrastructure services at cost or subsidized rates to lower the national cost structure and thus make it more affordable – and internationally competitive – the economy is being turned into a collection of tollbooths Small wonder that this year’s transitory wave of post-bubble books fail to place the financialization of the U.S. and global economies in this long-term context.
Michael Hudson is a former Wall Street economist. A Distinguished Research Professor at University of Missouri, Kansas City (UMKC), he is the author of many books, including Super Imperialism: The Economic Strategy of American Empire (new ed., Pluto Press, 2002) He can be reached via his website, email@example.com