Dr. Michael Hudson's Testimony before the Russian Parliament

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“Since 1995 I have been a consultant to the Duma’s Natural Resource committee, and have addressed the Duma on privatization issues on three occasions now. I am former balance-of-payments analyst for the Chase Manhattan Bank and Arthur Andersen, professor of international economics at the Graduate Faculty of the New School for Social Research, former chief economist of the Hudson Institute, current president of the Institute for the Study of Long-term Economic Trends (ISLET), advisor to the Canadian, U.S. and Mexican governments, UNITAR, and founder of Scudder Stevens’ sovereign debt mutual fund in 1990, the first global “junk bond” fund.

I am the author of Super Imperialism: The Economic Strategy of American Empire (1972, Holt Rinehart, trans. Spanish and Japanese), Global Fracture: The New International Economic Order (1978, Harper & Row, tr. Japanese), Canada in the New Monetary Order (1979: Butterfield), Trade, Development and Foreign Debt: Theories of Convergence and Polarization in the World Economy (2 vols. 1992, Pluto), and numerous other books.

Esteemed Mr. Zvolinsky, Dr. Lvov, Mr. Boldyrev and members of the Duma and Upper Chamber:

I am sure that Russians have grown tired of foreigners arriving on your shores to tell you how to run your society. I therefore will confine my remarks to discussing how wide your range of options is with regard to your negotiations with foreign investors in the United States and Europe, and with the IMF.

The most obvious question to be asked is whether foreign lenders and buyers of Russian companies have provided dollars that have been used to modernize Russia’s factories and agriculture. Or, have these dollars been used mainly to subsidize capital flight and to create a client oligarchy serving U.S. and European interests?

It is an axiom of power politics to defend against the enemy that potentially could materialize. In view of this principle one must ask whether America really wants to help Russia develop as powerful an economy as that of the United States. Does America want Russia to raise its living standards and consume most of its fuels and raw materials domestically? Or, does it see a chance to nail down its Cold War victory by destroying Russia’s potential power to be a rival, by turning it into an exporter of oil, gas and other raw materials? Do American diplomats want to help U.S. investors and companies acquire ownership of Russia’s mineral wealth and public monopolies, so that their profits will accrue to the U.S. and European economies? Does America want to make Russia dependent on imports of U.S. grain, chickens, cigarettes and other consumer goods, and even on American currency? Or has this been an accidental and unintended consequence of the advice that has been given since 1990?

Such questions virtually answer themselves. When Russia asks foreign advisors for help, to whom do these individuals owe their loyalty – to Russia, or to the U.S. Government agencies, the IMF and World Bank that pay them (or provide the money to Russia to pay them)?

Under these conditions, how good is the foreign advice that Russia can expect to get?

Before embarking on the reforms recommended by U.S. AID advisors, the IMF and World Bank, did Russia find the economic advice that these institutions have given Chile, Mexico, Yugoslavia and other countries good? Does the best way to restore living standards and productivity lie in imposing austerity that cuts back wages paid to public and private employees? Or does the shrinking of Russia’s domestic market lead to falling output and make the nation even more dependent on foreigners?

Is economic recovery helped by taxing labor and industry while freeing Russia’s privatized fuel and mining companies and public utilities from taxation? Or, should Russia use its natural resource wealth as the basis for public taxation? Should the government leave the profits and rental revenue from its oil and gas, nickel and other minerals in the hands of privatized firms, to be turned into interest and dividend payments and taken out of Russia? What will the fate of the ruble be in each case?

After inflation wiped out Russian savings in 1991-92, who had the money to buy the natural resources and other assets that Russia was privatizing, except foreigners and Russians with offshore bank accounts? Inasmuch as U.S. and European money has been given overwhelmingly to Russian oligarchs and their banks, might Russia have been better off without it?

What made Russia’s stock market the world’s best performer in 1997? Was it telling the world that Russia would use its natural advantages to develop its economic potential for the benefit of its own people? Or did it show that the country was giving away vast wealth at low prices that offered investors quicker gains than existed anywhere else in the world? What happened to the stock market gains made in these years, and to the equally quick gains in government bonds (GKOs)? Did these gains benefit Russia, or merely its oligarchy and foreign investors?

Do American geopolitical strategists fear that Russia might develop a form of economic organization that would show other countries that an alternative economic system exists to American-style finance capitalism? That Russia might move closer to the European Community as a counter-weight to U.S. world hegemony? Russia is a creditor nation – and that is its problem

Many Russians feel that their country is so deeply indebted that it has forfeited its room for economic maneuvering. They may be surprised to realize that Russia has become one of the world’s major creditor economies. Ironically, the poorer and more distressed a nation is, the more it tends to be a creditor economy. Meanwhile, the United States has become the world’s most highly indebted economy.

Russian families hold more $100 bills than circulate in the United States (in which only one-quarter of the printed notes circulate). The general estimate is that some $50 billion in U.S. currency presently circulates in Russia (up from $37 billion in 1995). By contrast, less than $20 billion in rubles are in circulation. Russia’s central bank holds only about $7 billion in foreign reserves, and much of this consists of gold bullion.

Technically speaking, holdings of U.S. currency represent loans to the U.S. Government – loans that do not bear interest. Russians holding this currency are creditors. They can exchange this credit for U.S. products or assets.

Russians also hold at least $200 billion abroad. This figure is based on IMF and other estimates of Russian capital flight amounting to $25 billion annually during 1991-99. (Estimates run to as high as $500 billion.) This money too can be spent on foreign assets, real estate, stocks, bonds, luxury cars, clothing, and the purchase of political favors, as well as to pay taxes to foreign governments on these holdings and the income they generate.

The United States thus is a debtor to Russia, but it has learned well how to play the debtor game in such a way as to come out ahead. It has turned its debtor position into a lever, borrowing at no interest charge (to the extent that its currency circulates abroad) or at low interest (mainly from central banks in countries that have no other use for their surplus dollars. Private investors recycle this money to Russia at exorbitant returns – as much as 100 percent annually during the GKO boom.

American affluence is literally a “flowing in.” It is an inflow of foreign money, skilled labor and imported goods that are paid for only with paper dollar-debts. So easily has America obtained foreign resources that it has been able to produce less and less within its own borders.

The large volume of capital flight out of Russia poses the natural question of whether it is legally the property of the Russian people. Does the government have a right to this money? Much of it represents tax evasion, most notoriously by false invoicing of exports or their sale below international value to affiliates controlled by Russian insiders.

Mexico and other countries where illicit capital flight has occurred have asked foreign nations to confiscate it under the law of unexplained enrichment. It is open to the Russian government to ask North America, Europe and East Asia to sequester such funds and return them to Russia. If the holders of these funds cannot show how they earned the money legally and properly declared it on their tax returns and other financial statements, a legal case can be made that it belongs rightly to the Russian people.

As a condition for resuming debt service foreign to foreign creditors, Russia is in a favorable position to bargain. Its government can demand that foreign economies freeze this $200 billion in flight capital and the assets into which it has been converted. Once these assets have been turned over to the Russian government, it may ask the holders of these assets to explain how they accumulated such large sums, given their low reported income. If they cannot explain it, these assets may be forfeited to the state under the doctrine of unexplained enrichment. This is the law accepted even by Switzerland, for instance, in the prosecution of former President Salinas’s family.

If foreign economies refuse to co-operate, it is open to Russia to point out that it lacks the means to pay precisely because foreign banks and the government regulators behind them have been complicit in promoting such tax evasion, financial fraud and capital flight. How to stabilize Russian finances by creating a rent-ruble

Mr. Zvolinsky is correct in warning that if Russia does not stabilize its fiscal system and defend the currency to the point where the economy is re-rubalized, Russia is in danger of falling apart into regions. The nation already is being reduced to Third World status, dependent on America and Europe for its food and even its means of payment.

Fortunately there is a way out. To start with, Russia can create its own money. It need not borrow foreign dollars to finance its budget and print rubles. These counterpart-dollars do not make printing rubles any less inflationary. There is no need for these dollars, which are used mainly to subsidize capital flight.

U.S. monetarist advisors are wrong in claiming that this government spending – or for that matter, printing the money to spend -would be inflationary. Prior to Chicago School evangelism it was basic monetary theory for over 200 years that in under-employment situations the creation of new money tends to put labor and physical capital to work. If Russia creates credit to pay wage arrears, pensions and to make other domestic payments, most such revenue will be re-spent within the Russia by its recipients, given the needy economic conditions of most workers and dependents. Only a relatively small amount of money will be saved as dollars. This proportion will diminish as Russia stabilizes its finances.

As my colleague Mr. Harrison has explained, Russia’s land, fuel and minerals and public monopolies are capable of generating a sufficient volume of economic rent to fund the government budget. At present, most of this rent has been relinquished to companies that have been privatized: the large fuel companies (Gazprom, Yukos and other oil companies), mining companies (Norilsk, etc.), and the telephone, electric power and other monopolies.

This rental income accruing to natural resources and monopolies has been freed for payment abroad by Russia’s failure to levy taxes on it. Leaving this revenue in the hands of managers and other new owners has enabled them to remit it abroad as dividend and interest payments. Also, fraudulent commercial practices have transferred exports at below-market prices to dummy companies created in Switzerland and the United States, and in offshore banking centers such as Cyprus, the British Channel Islands, the Caribbean islands and Panama.

The first element in my plan to re-rubalize the economy is to stabilize Russia’s fiscal finances by the only form of tax presently available to be collected in practice: the economic rent generated by Russia’s fuel and minerals companies, land and public utilities. Existing taxes on income and other wage levies should be discontinued, along with sales taxes and other taxes whose effect is to discourage new investment and employment. It is not necessary to burden Russian labor, industry and agriculture with taxes that absorb income that can better be used to restore living standards and to undertake new direct investment. Nuisance and “sin” taxes may be maintained and even increased, especially on alcohol and tobacco products. Tariff protection also may be employed during Russia’s transition period, as America has used it in similar circumstances.

These fiscal changes would help stabilize the ruble’s exchange rate. Public collection of economic rent can be collected without affecting the supply of fuels and other raw materials, land or public utility services. The government would spend this revenue primarily within Russia, except for the extent to which it chooses to pay interest and principal on Russia’s foreign debt. Domestic recipients of this government expenditure can be expected to spend most of the money within Russia, save for the portion they choose to convert into dollars.

My proposal will not be welcomed by the foreign investors that have bought stocks in Russian companies, or by U.S. strategists who would like to deprive the Russian government of this basic source of fiscal revenue. After all, the market value of Russia’s privatized firms is determined by discounting the future rent revenue that they can pay out in the form of interest and dividends. A rent-tax would drastically reduce the market value of such companies. It is not necessary to re-nationalize them to obtain this revenue. A rent-tax is legal under international law, as long as it is applied to domestic residents and foreigners equally.

Regarding the insider dealings by which these firms were acquired in the first place by Russian financial-industrial groupings (FIGs), Michael Bernstam has pointed out that a legal basis exists for re-acquiring them. Their back taxes and tax-evasion penalties have come to at least equal their purchase price. For these companies, settling their debts by forfeiting their stock holdings would be at best a wash. If other funds remain due, these can be dealt with appropriately by the criminal justice system. Is Russia obliged to repay its foreign loans? If so, on what terms should it do so?

In my report that has been submitted to you, “The Economic War Against Russia – and the Way Out,” I emphasize that stabilization of the ruble requires establishment of a true banking system to replace what presently exists under the name of banks. There is no need for Russian money creation to be backed by dollars or other foreign exchange. Indeed, the loans by the IMF and other foreign lenders have been counter-effective.

The IMF loans and other credits have been squandered unproductively. Most of the money has been turned over to the oligarchic banks in settlement of “forward currency contracts” that are, in effect, no-lose gambles against the ruble. The banks wrote contracts to exchange rubles for dollars at some future date (normally three months) at the existing rate. As the ruble’s exchange rate depreciated, the banks pocketed the difference. (To be sure, only politically favored banks were able to make such deals.) The IMF has euphemized this practice as “supporting the ruble,” but it has been simply a giveaway to the banks and other speculators.

These observations pave the way for asking how much money Russia really owes America, Europe and East Asia.

Russia has three options open to it as an alternative to servicing these faux-debts. First of all, many of the debts owed by the banks and the monetary authority are not debts of the Russian people. If the corporate debtor entities declare bankruptcy, their debts are wiped out. Over and above this, the debts that the Yeltsin Family have run up were done so without Duma approval. They thus are more in the character of medieval debts to Europe’s kings and princes than national debts to which the people are committed to repay under the rules of parliamentary democracy.

In fact, many of the circumstances surrounding these transfers are now under civil and criminal investigation in the United States itself, with regard to the evidently corrupt self-interest in which the Harvard Boys engaged while working for AID. Anne Williamson provides details in her forthcoming book Contagion: The Betrayal of Liberty – Russia and the United States in the 1990s.

A large portion of Russia’s international debts to commercial banks may be annulled under the U.S. laws of fraudulent conveyance. This body of law dates back to the time of the American Revolution, especially New York State law. At the time of the Revolution, many New Yorkers owed money to British lenders. A law was passed that if a creditor extends a loan to a borrower, but has no reasonable idea of how the debtor can obtain the money to repay the loan, it is annulled. This law was applied in the 1980s to numerous leveraged buyouts financed by junk bonds. Law firms have warned money managers that foreign debtor governments might avail themselves of its protection. Russia would appear to be a prime candidate.

A third ground for annulling Russia’s foreign debt is the doctrine of odious debts. Patricia Adams has conveniently collected the history of law and legal theory regarding such debts in her book Odious Debts. The documentation is in such books, but Russia cannot expect U.S, IMF and other foreign advisors to provide it freely.

Taken together, Russia may use these three principles to negotiate a solution to its foreign debts from the Soviet and Yeltsin eras. Conclusion

U.S. advisors have tried to convince Russians that it is necessary to choose between the cumbersome old Soviet system and an even more corrosive free-enterprise form of monetarism. There is a pretense that Russian voters somehow must find a midpoint between “reform” and a return to the past.

But this is only propaganda. There is a third way that achieves the best efficiencies of market allocation of resources without the corruption that the Yeltsin-Chubais regime has imposed on behalf of Russia’s foreign adversaries. American finance capitalism itself suffers from the same monetarist disease that its advisors are trying to force upon Russia. U.S. and Western European savings have become de-coupled from new direct investment in building factories and employing labor. It has become easier to ride the wave of asset-price inflation – the stock market and real estate bubble – than to create new material means of production.

Instead of seeking to earn profits through direct investment, speculators and other investors have sought to get a free ride from creating private monopolies and extorting economic rent. The upshot is land and real estate speculation, and corporate takeovers. This flurry of activity has been financed by loading the economy down with debt – unproductive debt that does not find its counterpart in creating new means of production to pay it off.

Russia can avoid this debt overhead and takeover movement simply by taxing what is unearned – the free rental revenue produced by its raw materials, its land and its natural monopolies in the form of hitherto public utilities. This would finance the public budget.

Meanwhile, a viable banking system – still to be created almost from scratch – would channel savings into productive lending to create new means of production and re-employ Russian labor. It thus would achieve the dream that Russia had imagined it could get from following U.S. and IMF advice, before being tricked by the public relations campaign waged by foreign monetarist advisors.

Many people in America, Western Europe and East Asia would welcome a Russian initiative that would break from the monetarist orthodoxy that the IMF and U.S. AID have imposed on third world countries, East Asian economies (including even Japan) and other regimes throughout the world.

In sum, Russia has a great pool of support for true reforms that bear little resemblance to what has passed for “reform” at the hands of the Yeltsin-Chubais family.”