"The Game is Over. There won't be a rebound": Interview with Michael Hudson
on the economy
By Mike Whitney
Created Jun 23 2008 - 8:54am
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 steers its monetary policy almost
exclusively with domestic objectives in mind. This means ignoring the
balance of payments.From the U.S. vantage point, sup****ting the dollars
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. These markets fall whenever there's serious talk of an interest
rate
increase,because it discourages speculation and that's what the Bubble
Economy is still based on these days. Higher rates and a stock-market
downturn 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 dollars exchange rate. So Mr. Bernankeıs statements are merely
being polite in not rubbing the faces of European and Asian governments in
the fact that U.S.officials are not at all unhappy to see the dollars
exchange rate plunge.U.S. officials believe that dollar depreciation will
help their ex****ters, especially in the aircraft and other
military-industrial sector. Its foreign investors and central banks who
must
absorb the loss in their dollar holdings as valued in their own domestic
currencies. Like the domestic U.S. economy itself, the global financial
system is all about getting a free lunch. When Europe and Asia receive
excess dollars, these are turned over to their central banks. Until the
recent decision to create sovereign wealth funds, these government bodies
had little alternative but to recycle these dollar inflows back to the
United States by buying U.S. Treasury bonds. This financed the domestic
U.S.federal budget deficit, which stems largely from the war in Iraq that
most foreign voters oppose. Unless foreign governments are willing to make
a
structural break to change the world monetary system, 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.
MW--How do you explain the soaring price of oil? Is it mainly a
supply/demand issue or are speculators driving the prices up?
MH: It's true that enormous amounts of speculative credit are going into
commodity index funds. Forward purchases increase the demand for
deliveries
of oil and other raw materials. But bear in mind also that as the dollar
depreciates, OPEC countries have sought to stabilize their receipts in
euros, and to offset their losses they are suffering on the
dollar-denominated securities they have bought with past ex****t proceeds.
For over 30 years they have been pressured to recycle their oil earnings
into the U.S. stock market and make loans to U.S. financial
institutions.They have taken large losses on these investments (such as
last
years contributions to bail out Citibank), and are trying to recoup them
via
the oil market. OPEC officials also point 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. Look at it from their point of view. They see that the
U.S.invasion of Iraq was a win-win situation as far as the oil industry is
concerned. If America conquers Iraq and forces the Oil Agreement
through,U.S. companies will be able to grab the world's largest available
pool of oil for a generation, and U.S. officials can use the oil weapon
against oil-deficit countries. Last week the U.S. oil firms managed to
bump
Russia's oil industry out of the Iraq picture, reversing the trend that
had
been developing under Saddam. And if the war continues to be a military
and
economic disaster,the price of oil will skyrocket, providing a price
umbrella for domestic U.S. producers as you can see from how the stock
market is raising its valuation of Exxon and other oil majors. So the
question is by no means just an economic one. 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 ****pping 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.
MW--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 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?
MH: The Fed's idea was 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 th
eproblem can be cured by yet more time.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 reflatethe real estate market can't work, but can
only
cut losses for the financial institutions who have become the nation's
major
political campaign contributors. Mortgage arrears, defaults and
foreclosures
are rising, and much property has become unsaleable except at distress
prices that leave homeowners with negative equity. This prompts them to do
what Donald Trump would do in such a situation: to walk away from their
property. The banks will be left holding the bag, just as they were in
Japan
after 1990. In Japan's case, real estate prices declined steadily every
quarter for 17 years! That should give you a flavor of how serious the
U.S.
problem is today. 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 and derivatives. But this is 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 that if it doesn't keep bailing them out, 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
are following the traditional "Big fish eat little fish" principle of
favoring the vested interests. They are more willing to bail out the big
financial institutions than to bail out savers,pensioners, Social Security
recipients and other small fry.
MW: 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.4.1data "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%."
(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?
MH: 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's been buying junk securities, leaving sound
Treasury
securities on the banking system's balance sheet. Meanwhile, false
re****ting
will help financial institutions avoid the appearance of
insolvency.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. 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 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 and sales 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,
pro****tionally. 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.
MW--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?
MH: It looks like the practice of off-balance-sheet accounting has become
obsolete, because nearly all the banks have abused it in a fraudulent
way.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 traditionally has protected European
investors. But the United States put its faith in self-regulation,² by
banks in a sector where financial crime always has been rife. We've
already seen criminal charges brought against Bear Stearns, and the FBI
has
announced that it's in the middle of a far-reaching fraud investigation. I
hope they get Countrywide and the other crooked institutions but nearly
all the big banks and companies have been involved.The problem with
financial institutions is that they live in the short run. This actually
has
paid them. They declared large profits on fraudulent loans, and paid out
an
amount equal to their entire capital on wages and salaries for upper
management, and dividends. So their managers have stripped them dry,
leaving
them today with Negative Equity. This is the same situation they were in
back in 1980, but at that time the reason was that interest rates had
soared
to 20% in the Carter-Volcker inflation.Today, interest rates are low, and
the banks already are broke. If this really were a free market economy,
their shareholders would be wiped out and the government would demand
return of the exorbitant bonuses andsalaries.Instead, it looks like the
government will bail out the banks. But I think it's wrong to lend money
to
a bank today without getting preferential treatment over its stockholders
and bondholders, plus secure collateral. In view of the heavy losses of
German banks in Saxony and Düsseldorf in the U.S. subprime market last
summer, and the heavy losses by Arab sheiks in Citibank stock last summer,
it's unlikely that investors will buy mortgages that no major bank or
government agency stands behind. So something has to give.
MW--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?
MH: The idea that we're even in a business cycle is whistling in the dark.
To think of the economy being in a cycle is to imply an automatic recovery
is in store. This free-market idea was developed at the National Bureau of
Economic Research by opponents of government regulatory policy.The fantasy
is that the economy oscillates in a fairly smooth and regular sine curve.
But this always has been a fiction. 19th-century writers didn't speak of
economic cycles, but rather of periodic financial crises. There is a slow
buildup, and a sudden plunge, so the shape is ratchet-shaped. 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,cor****ate
stocks and bonds. In effect, the interest charge was simply added onto the
debt balance. But now prices are falling, leaving families,companies and
many Wall Street firms with negative equity. Asset-price inflation fueled
by
the Federal Reserve is giving way to debt deflation. 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. The United States and other
countries have reached the point where interest and amortization payments
are absorbing the entire economic surplus of so many individuals, so many
companies and so many government bodies that new construction, investment
and employment are grinding to a halt. Families, real estate investors and
companies are obliged to use their disposable income to pay their
creditors.
This leaves them without enough money to sustain the living standards of
recent years and they no longer can wipe out their debts by declaring
bankruptcy as in times past, because Congress has passed the harsh
bankruptcy law that credit-card and bank lobbies paid them to pass.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?
MH: Prices will keep going back down, because they no longer can be
bolstered by interest rates plunging further. The zero-amortization
mortgages and low or zero (or even negative) down payments in recent years
are as low as can be achieved mathematically. This means the end of the
Bubble Economy. The actual real estate market is much worse even 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. This means that the banks can't sell their mortgage-backed
securities without taking big losses except to the government at prices
way above what the market will pay. The Fed already has let them borrow
against collateral at way, way more than it is worth in sharp contrast to
how it treats middle-class debtors.
MW--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 adviser 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?
MH: In economic terms America today is in as optimum a position as it is
can
be. That's actually bad news, because an optimum position is,
mathematically
speaking, one in which you can't move without making your situation worse.
This is the position we're in now, and it's already as good as it can get.
There's nowhere to move, at least within the existing structure. The
market
can't be stabilized, because it was based on fictitious prices to begin
with. It's hard to impose fiction on reality for very long. The rest of
the
world has woken up although not Congress, it seems. In times past,
bankruptcy would have wiped out the bad debts.The problem with such
write-offs is that bad the savings that have been steered into bad loans
must follow suit and go by the boards. But today, the very wealthy hold
most
of the savings, so the government doesn't want to let 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 U.S. canıt reduce its
balance-of-payments deficit without scaling back its military spending.
Meanwhile, 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. At a point these actions threaten to leave
the
United States economically isolated as foreign economies protect
themselves
from U.S. credit creation out of thin air to buy their ex****ts and
companies. The question is, will Obama and other politicians be willing to
tell the public the bad news that restoring vitality will take radical
measures? The way to do this is to present it as good news. There ARE
reforms that can help matters, and they are reforms that Americans have
endorsed for a century, ever since the Progressive Era.One problem is that
lobbyists for the vested interests are sopowerful that they probably can
get
Congress to water down any real so much that the economic situation will
to
keep on getting worse and worse before the needed reforms can be enacted.
On
the other hand, only in such a situation CAN they be enacted. I think that
Mr. Obama would be wise to explain this before taking office. As
president,
he will have to do what FDR did, and challenge the financial oligarchy
with
new regulatory agencies, staffed with real regulators, not deregulators as
under the Bush-Clinton-Bush regime. His political hope to avoid being
blamed
for the economic problems in which 16years of Clinton and Bush policies
have
pushed the United States is to come out in the fall probably after the
election and blame the Republicans for their regressive tax policies.
This
would help bring pressure on the new Democratic Congress to back a return
to
progressive taxation and serious financial restructuring. For starters,
Mr.
Obama should repeal the Clinton repeal of Glass Steagall. And he should
make
large depositors and savers take the losses on their bad bets. Most of
all,
he will have to make the tax system back progressive again if the domestic
market is to recover. Also, a good tax code should encourage equity
financing instead of debt pyramiding as is now the case, thanks to the
banking lobby. This winding down of U.S. debt can best be achieved by
removing the tax-deductibility of interest payments,and do what the
original
1913 income tax did: tax capital gains at normal income rates rather than
subsidizing speculation. The great majority of such gains accrue to real
estate speculators, not to industrial entrepreneurs. Mr. Obama can help
revive the middle class by paying Social Security and medical care out of
the general budget, not as user fees borne by the lowest wealth brackets
as
at present. Until this change is made, FICA withholding should be levied
on
total income, without any upper cut-off point. If there is a cut-off
point,
it should be to exempt people who earn LESS than $60,000 a year. This
would
end up being fairly revenue-neutral.Pres. Obama should explain 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 as the tax code was meant to do prior to
the 1980s.Unless Mr. Obama does this, what used to be a democracy will be
turned into an oligarchy. The problem with oligarchies is that
historically
they are so shortsighted that they stifle the domestic economy, driving
enterprise and emigration abroad. This threatens to reverse America's
long-term affluence. The word means literally a flowing-in an inflow of
capital, of skilled immigrants and other labor, of technology, and of
foreign sup****t. All this has now been put in danger by the policies
pursued
since the 1980s. Industry and savings already have begun to flow
abroad.Skilled labor and technology is next, while domestic infrastructure
is sold off to foreigners. Free roads will be turned into toll-roads, and
the fees,interest and profits sent abroad. If this trend cannot be
reversed
in the present economic squeeze, U.S. living standards and the domestic
market will be subject to IMF-style austerity and shrink.
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@[EMAIL PROTECTED]
Whitney
--
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"A little patience and we shall see the reign of witches pass over, their
spells dissolve, and the people recovering their true sight, restore their
government to its true principles. It is true that in the meantime we are
suffering deeply in spirit,
and incurring the horrors of a war and long oppressions of enormous public
debt. But if the game runs sometimes against us at home we must have
patience till luck turns, and then we shall have an op****tunity of winning
back the principles we have lost, for this is a game where principles are
at
stake."
-Thomas Jefferson
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