[R-G] An Interview with Michael Hudson on the Economy

[Anthony Fenton]

An Interview with Michael Hudson on the Economy
The Game is Over. There Won't be a Rebound
http://counterpunch.org/whitney06212008.html

By MIKE WHITNEY

Mike Whitney: Fed chairman Bernanke has been on a spree lately,  
delivering three speeches in the last two weeks. Every chance he gets,  
he talks tough about the strong dollar and "holding the line" against  
inflation. Treasury Secretary Henry Paulson even said that  
"intervention" in the currency markets was still an option. Is all of  
this jawboning just saber rattling to keep the dollar from plummeting,  
or is there a chance that Bernanke actually will raise rates at the  
Fed's August meeting?

Michael Hudson: The United States always has steered its monetary  
policy almost exclusively with domestic objectives in mind. This means  
ignoring the balance of payments. Like the domestic U.S. economy  
itself, the global financial system also is all about getting a free  
lunch. When Europe and Asia receive excess dollars, these are turned  
over to their central banks, which have little alternative but to  
recycle these back to the United States by buying U.S. Treasury bonds.  
Foreign governments – and their taxpayers – are thus financing the  
domestic U.S. federal budget deficit, which itself stems largely from  
the war in Iraq that most foreign voters oppose.

Supporting the dollar’s exchange rate by the traditional method of  
raising interest rates would have a very negative effect on the stock  
and bond markets – and on the mortgage market. This would lead foreign  
investors to sell U.S. securities, and likely would end up hurting  
more than helping the U.S. balance of payments and hence the dollar’s  
exchange rate.

  So Bernanke is merely being polite in not rubbing the faces of  
European and Asian governments in the fact that unless they are  
willing to make a structural break and change the world monetary  
system radically, they will remain powerless to avoid giving the  
United States a free ride – including a free ride for its military  
spending and war in the Near East.

Mike Whitney : How do you explain the soaring price of oil? Is it  
mainly a supply/demand issue or are speculators driving the prices up?

Michael Hudson: It’s true that enormous amounts of speculative credit  
are going into commodity index funds. But bear in mind that as the  
dollar depreciates, OPEC countries have been holding back supply  
largely to stabilize their receipts in euros and to offset their  
losses on the dollar securities they have bought with their past  
export proceeds. For over 30 years they have been pressured to recycle  
their oil earnings into the U.S. stock market and loans to U.S.  
financial institutions. They have taken large losses on these  
investments (such as last year’s money to bail out Citibank), and are  
trying to recoup them via the oil market. OPEC officials also have  
pointed to a political motive: They resent America’s military  
intrusion in the Middle East, especially in view of how much it  
contributes to the nation’s balance-of-payments deficit and federal  
budget deficit.

The U.S. press prefers to blame Chinese, Indian and other foreign  
growth in demand for oil and raw materials. This demand has  
contributed to the price rise, no doubt about it. But the U.S. oil  
majors are receiving a windfall “economic rent” on the price run-up,  
and are not at all unhappy to see it continue. By not building more  
refining and shipping capacity, they have created bottlenecks so that  
even if foreign countries did supply more crude oil, it would not be  
reflected in refined gasoline, kerosene or other downstream product  
prices.

Mike Whitney: The Fed has traded over $200 billion in US Treasuries  
with the big investment banks for a wide variety of dodgy collateral  
(mostly mortgage-backed securities). How can the banks possibly hope  
to repay the Fed when their main sources of revenue (structured  
investments) have been cut off? Are the banks secretly using the money  
they borrow via repos from the Fed to dabble in the carry trade or  
speculate in the futures markets?

Michael Hudson: The Fed’s idea was merely to buy enough time for the  
banks to sell their junk mortgages to the proverbial “greater fool.”  
But foreign investors no longer are playing this role, nor are  
domestic U.S. pension funds. So the most likely result will be for the  
Fed simply to roll over its loans – as if the problem can be cured by  
yet more time.

But when a bubble bursts, time makes things worse. The financial  
sector has been living in the short run for quite a while now, and I  
suspect that a lot of money managers are planning to get out or be  
fired now that the game is over. And it really is over. The Treasury’s  
attempt to reflate the real estate market has not worked, and it can’t  
work. Mortgage arrears, defaults and foreclosures are rising, and much  
property has become unsaleable except at distress prices that leave  
homeowners with negative equity. This state of affairs prompts them to  
do just what Donald Trump would do in such a situation: to walk away  
from their property.

The banks are trying to win back their losses by arbitrage operations,  
borrowing from the Fed at a low interest rate and lending at a higher  
one, and gambling on options. But options and derivatives are a zero- 
sum game: one party’s gain is another’s loss. So the banks  
collectively are simply painting themselves into a deeper corner. They  
hope they can tell the Fed and Treasury to keep bailing them out or  
else they’ll fail and cost the FDIC even more money to make good on  
insuring the “bad savings” that have been steered into these bad debts  
and bad gambles.

The Fed and Treasury certainly seem more willing to bail out the big  
financial institutions than to bail out savers, pensioners, social  
Security recipients and other small fry. They thus follow the  
traditional “Big fish eat little fish” principle of favoring the  
vested interests.

Mike Whitney: According to most estimates, the Fed has already gone  
through half or more of its $900 billion balance sheet. Also,  
according to the latest H.4.1 data  "the current holdings of Treasury  
bills is $25 billion.  This is down from some $250 billion a year ago,  
or a net reduction of 90 per cent." (figures from Market Ticker)  
Doesn't this suggest that the Fed is just about out of firepower when  
it comes to bailing out the struggling banking system? Where do we go  
from here? Will some of the larger banks be allowed to fail or will  
they be nationalized?

Michael Hudson: You need to look at what the Treasury as well as the  
Fed is doing. The Fed can monetize whatever it wants. And as you just  
pointed out in the preceding question, it has been buying junk  
securities in order to leave sound Treasury securities on the banking  
system’s balance sheets. Government bailout credit will keep the big  
banks alive. But many small regional banks will go under and be merged  
into larger money-center banks – just as many brokerage firms in  
recent decades have been merged into larger conglomerates.

False reporting also will help financial institutions avoid the  
appearance of insolvency. They will seek more and more government  
guarantees, ostensibly to help middle-class depositors but actually  
favoring the big speculators who are their major clients.

What we are seeing is the creation of a highly concentrated financial  
oligarchy – precisely the power that the Glass-Steagall Act was  
designed to prevent. A combination of deregulation and “moral hazard”  
bailouts – for the top of the economic pyramid, not the bottom – will  
polarize the economy all the more.

Cities and states will preserve their credit ratings by annulling  
their pension obligations to public-sector workers, and raising excise  
taxes – but not property taxes. These already have fallen from about  
two-thirds of local budgets in 1930 to only about one-sixth today –  
that is, a decline of 75 percent, proportionally. While the debt  
burden and the squeeze in disposable personal income is pressuring  
workers, finance and property are using the crisis to get a bonanza of  
tax relief. Democrats in Congress are as far to the right as George  
Bush on this, as their base is local politics and real estate.

Mike Whtney: According to the Financial Times: "Analysts at Citigroup  
said a planned tightening of the rules regarding off-balance sheet  
vehicles would force banks to reconsider arrangements and could result  
in up to $5,000bn of assets coming back on to the books. The off- 
balance sheet vehicles have been used by financial institutions to  
keep some assets off their balance sheets, thereby avoiding the need  
to hold regulatory capital against them." Is there any way the banks  
can find investors with "deep enough pockets" to provide the capital  
they need to meet the requirements on $5 trillion dollars? Are most of  
these off-balance sheets assets mortgage backed securities and other  
hard-to-value bonds?

Michael Hudson: The practice of off-balance-sheet accounting already  
has become quickly obsolete this year. The United States is going to  
adopt Europe’s normal “covered bond” practice of bank head-office  
liability for mortgages and other loans. (The Wall Street Journal had  
a good article on this on June 17, anticipating that the U.S. covered  
bond market might rise quickly to $1 trillion as early as next year.)

This coverage is what has given European banks protection. In view of  
the heavy losses of German banks in Saxony and Düsseldorf in the U.S.  
subprime market last summer, it’s unlikely that investors will buy  
mortgages that no major
bank or government agency stands behind.

Regarding more investor bailouts, I don’t see that it makes sense to  
lend money to a bank today without getting preferential treatment over  
existing holders, plus secure collateral. Government guarantees might  
help, especially for foreign investors. But then, the dollar’s plunge  
is a problem here.

Mike Whitney: Many of the TV financial gurus --as well as Henry  
Paulson--keep assuring us that the worst is behind us, but I don't see  
it. Foreclosures are increasing, the dollar is falling, unemployment  
is rising, manufacturing is sluggish, food and fuel are soaring, and  
consumers are backed up on their credit cards, student loans and house  
payments. Where would you say we are in the present cycle? What will  
it take to rebound from the current slump? Will the stock market take  
a beating before all this is over? What do you think the greatest  
problem facing the economy is; inflation or deflation?

Michael Hudson:  The idea that we’re even in a business “cycle” is  
whistling in the dark. If we’re in a cycle, then that implies there’s  
an automatic recovery in store. This happy free-market idea was  
developed at the National Bureau of Economic Research by opponents of  
government regulatory policy. But the economy doesn’t move by a sine  
curve. There is a slow buildup, and a sudden plunge, so the shape is  
ratchet-shaped. This is why 19th-century writers didn’t speak of  
economic cycles, but rather of periodic financial crises.

Today’s plunging real estate and stock market prices are not a self- 
correcting ebb and flow in which downturns set in motion automatic  
stabilizers that produce recovery. Each U.S. recovery since World War  
II has started out from a higher level of debt. The result is like  
driving a car with the brakes pressed more and more tightly. Alan  
Greenspan at the Federal Reserve flooded the banking system with  
enough credit to enable debts to be carried by borrowing against the  
rising price of homes and office buildings, corporate stocks and  
bonds. In effect, the interest charge was simply added onto the debt  
balance.

But today, the prospects are dim for paying off debts out of further  
price gains for homes and real estate. Speculators have pulled out of  
the market – and as late as 2006 they accounted for about a sixth of  
new purchases. Asset-price inflation fueled by the Federal Reserve –  
is giving way to debt deflation. The United States and other countries  
have reached a limit in which scheduled interest and amortization  
absorb the entire economic surplus of so many individuals, companies  
and government bodies that new construction, investment and employment  
are grinding to a halt. Families, real estate investors and companies  
are obliged to use their entire disposable income to pay their  
creditors or face bankruptcy. This leaves them without enough money to  
sustain the living standards of recent years.

This means that there won’t be a rebound, and it will take longer than  
2009 to recover.

MW: I read about 8 or 9 articles every day about the meltdown in  
housing. I always tell my wife that its like reading a Tom Clancy  
novel except the ending is less certain. As Yale economist Robert  
Schiller pointed out last month; the decline in prices is now greater  
than it was during the Great Depression. Will prices find a bottom in  
2009 or will it take longer? If prices keep falling then how are the  
banks going to sell the hundreds of billions of dollars of mortgage- 
backed securities that they are presently holding?

Michael Hudson: Prices will keep going down, because they have been  
fed by plunging interest rates, zero-amortization mortgages and low or  
zero (or even negative) down payments in recent years. That world has  
ended.

It means that the banks can’t sell their mortgage-backed securities –  
except to the government, at a loss except to insiders. The actual  
losses are much worse than the present price statistics show, because  
many people are frozen in with negative equity. So instead of price  
declines, we’ll simply see many more foreclosures.

Mike Whtiney: How serious is the current crisis in the financial  
markets and housing and what steps do you think Obama or McCain should  
take to stabilize the markets, reduce the deficits, strengthen the  
dollar, increase employment, and put the economy on solid footing? Is  
it possible to have a strong economy without policies that distribute  
the nation's wealth more equitably? As chief economic advisor to Rep  
Dennis Kucinich, what one bit of advice would you give to Obama to  
restore America's economic vitality and put the country on the right  
path again?

Michael Hudson: In academic economic terms, America has never been in  
as “optimum” a position as it is today. That’s the bad news. An  
optimum position is, mathematically speaking, one in which you can’t  
move without making your situation worse. That’s the position we’re  
now in. There’s nowhere to move – at least within the existing  
structure. “The market” can’t be stabilized, because it was artificial  
to begin with, based on fictitious prices. It’s hard to impose fiction  
on reality for very long, and the rest of the world has woken up.

In times past, bankruptcy would have wiped out the bad debts. The  
problem with debt write-offs is that bad savings go by the boards too.  
But today, the very wealthy hold most of the savings, so the  
government doesn’t want to have them take a loss. It would rather wipe  
out pensioners, consumers, workers, industrial companies and foreign  
investors. So debts will be kept on the books and the economy will  
slowly be strangled by debt deflation.

The US can’t reduce the balance-of-payments deficit without scaling  
back its foreign military spending. Congress is refusing to let  
foreign governments invest in much besides overpriced junk here, so  
central banks are treating the dollar like a hot potato, trying to buy  
foreign assets that can play a role in their own future economic  
development.

I think that at some point Obama will have to tell the public the bad  
news that restoring vitality will take radical measures – probably  
ones that Congress will try to water down so much that things are  
going to get worse – much worse – before the needed reforms will be  
made. He can say this before taking office, blaming the Republicans  
for their regressive tax policies and at the same time bringing  
pressure on the new Democratic Congress to back a return to  
progressive taxation and serious financial restructuring. As  
president, he will have to do what FDR did, and challenge the  
financial oligarchy with new government regulatory agencies staffed  
with real regulators, not deregulators as under the Bush-Clinton-Bush  
regime.

He should make large depositors and “savers” take the losses on their  
bad bets. And he should repeal the Clinton repeal of Glass Steagall.

Most of all, he will have to make the tax system back progressive  
again if the domestic market is Social Security and medical care  
should be paid out of the general budget, not as user fees. And until  
this change is done, FICA withholding should be levied on total  
income, without an upper cutoff point. There should be a LOWER cut-off  
point, however: Only people who earn over $60,000 a year should  
contribute. This would end up being fairly revenue-neutral. Pres.  
Obama should say that his policy is not to “soak the rich.” It is to  
make them pay their way once again by favoring a strong middle class.

Unless he does this, what used to be a democracy will be turned into  
an oligarchy. And oligarchies historically are so short-sighted that  
they stifle the domestic economy, driving enterprise and emigration  
abroad. This threatens to reverse America’s long-term affluence, which  
means literally a flowing-in – an inflow of capital, of skilled  
immigrants and other labor, of technology, and of foreign support. All  
this has now been put in danger by the policies pursued at least since  
1980.

Michael Hudson is a former Wall Street economist specializing in the  
balance of payments and real estate at the Chase Manhattan Bank (now  
JPMorgan Chase & Co.), Arthur Anderson, and later at the Hudson  
Institute (no relation). In 1990 he helped established the world’s  
first sovereign debt fund for Scudder Stevens & Clark. Dr. Hudson was  
Dennis Kucinich’s Chief Economic Advisor in the recent Democratic  
primary presidential campaign, and has advised the U.S., Canadian,  
Mexican and Latvian governments, as well as the United Nations  
Institute for Training and Research (UNITAR). 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, mh at michael-hudson.com