Dollar War in Detail

Eric Janszen, Interview with Dr. Michael Hudson
6 November, 2010

Janszen (E): What I’m noting, starting with the gold crisis over the last few weeks, and the public nature of some of the complaints that we’re hearing out of Brazil and China and the front page of the Financial Times, we seem to be heading into a pretty serious currency crisis.

Hudson (H): Yes, the currency crisis is caused by what’s called Quantitative Easing (QE) – flooding the economy with credit, and specifically Ben Bernanke’s and Tim Geithner’s threat to create another $1 trillion worth of new Federal Reserve credit over the next twelve months. The Financial Times reports that all of the last $2 trillion the Fed created has gone to the BRIC countries (Brazil, Russia, India and China) and to Third World raw materials exporters. Since the start of 2009 this speculative dollar outflow has pushed up the Brazilian real by 30 percent, from 2.50 to 1.75 per dollar.

This has created a bonanza for speculators in the carry trade. Arbitrageurs can borrow from U.S. banks at 1% interest (and banks don’t have to pay anything on their own gambles), buy a Brazilian bond and get almost 12%, and pocket the difference. And as this carry trade pushes up non-dollar currencies, the speculators gets not only more than the 10 point interest-rate difference but also the currency revaluation as the Brazilian real (R$) is pushed up against the dollar.

Meanwhile, the export trade is destabilized. If Brazilian exporters had contracts denominated in dollars, they receive less of their own currency. Their aircraft and other manufactures become more costly relative to products of dollar-linked countries. This hurts their markets, and squeezes profits. This is why Brazil’s finance minister (Guido Mantega) said that the currency war is turning into a trade war.[1]

Japan’s currency also has been pushed up as its own earlier carry trade is unwound. After 1990 the Bank of Japan did what the U.S. Federal Reserve is doing today: it flooded the market with liquidity that lowered interest rates. Banks sought to “earn their way out of negative equity” by financing the international carry trade. Speculators borrowed yen to buy Icelandic and other bonds yielding high rates of return. But as Greece, Ireland and other countries are now becoming more risky, speculators are unwinding their positions and paying back the yen they have borrowed. This currency play is pushing up the yen’s exchange rate – despite the fact that Japanese borrowing rates are now only 0.1%.

The Bank of Japan has fought to stabilize its exchange rate by keeping its foreign-currency repayments into dollars, recycling $60 billion into U.S. Treasury bills. It is doing this in order to protect Japan’s export competitiveness by preventing the yen’s exchange rate from being forced up. But in the last few weeks U.S. officials have accused China and other countries of being aggressive currency manipulators indulging in “competitive non-appreciation,” when they simply are trying to keep their exchange rates stable in the same way that Japan is doing. This only infuriates other countries by accusing them of “manipulating” the currency, when they are simply trying to defend themselves against the $2 trillion onslaught of QE from the United States already, with up to a trillion dollars more threatening to be poured into the world’s foreign exchange markets.

This trillion dollar injection of dollar liquidity is a base for being multiplied ninety-nine times by putting down just 1%. So finance ministers are beginning to ask themselves what is to stop the United States from creating enough credit to buy up all the real estate, all the companies and every bit of stock in the world – and make the currency gain to pay off the loans in devalued dollars. Without isolating the dollar by imposing currency controls, U.S. banks have an infinite capacity to create credit and buy up foreign resources.

Sellers of foreign real estate, companies, stocks and bonds turn the dollars they receive over to their banks, which turn them over to the central bank – which tries to hold down their exchange rate by buying U.S. Treasury bonds that yield only 1% interest. So the U.S. is betting that it can flood the global economy with easy dollar credit and achieve what used to require an army to conquer: to obtain ownership of foreign land and property, mineral rights and other assets. This is now done by financial aggression, without the expensive overhead of an armed invasion. It is like a neutron bomb: it doesn’t destroy property; it keeps it in place for the financial aggressors to appropriate.

E: So tell me what the thinking is. Clearly the cover for all this talk about deflation (and what is somewhat hard to understand) is how to support it when oil prices and metal prices and commodity prices are rising. It doesn’t make any sense.  

H: I can tell you how it began and what it mutated into. It began with the decision not to reduce debt in the American economy. So the starting point is that one-third of American homes are in negative equity. The Feds thought what we need to do is re-inflate prices back to bubble levels, so as to keep the debts on the books and save the Banks from having negative equity. The political cover story was to rescue homeowners from negative equity. But their negative equity was that of the banks, and people have began to walk away from their homes (“jingle mail”).

So the Fed moved to re-inflate the economy by flooding financial markets with liquidity, giving banks almost free money (at 1%). The Fed believed that it could “push on a string,” and that the banks would lend it out.

For a century, economic textbooks have taught the money-price tautology MV = PT. Money (V) times Velocity (V, a residual) equals Price (P) times Output or Transactions (T).  The first error here is that the price being referring to is commodity prices, not asset prices. Banks lend mainly to buy assets in place. Some 70% of bank loans are for real estate. Most of the rest is for stocks, bonds and currencies, not goods and services. So injections of credit inflate asset prices – and this is what Alan Greenspan believed was “wealth creation.” It meant improving balance sheets by inflating assets faster than debts were growing. This always is a self-terminating process, but the financial sector – like politicians – notoriously lives in the short run. The idea is to take as much salary and bonuses as possible before the bubble bursts.

William Dudley at the New York Fed and Ben Bernanke have decided that the way to restore bank solvency is to inflate the economy out of debt. This means “to borrow one’s way out of debt,” because inflation is caused by banks providing credit to buy more – more assets in this case. To spur inflation – to raise prices above today’s Negative Equity levels – the Fed wants banks to lend out more credit. But what actually is happening is that most Americans are having to pay down their mortgages, student loans, credit-card debts and other obligations. This is why the U.S. savings rate has gone up from 0% three years ago to almost 3% today. It is going up not because people are becoming more prudent and deciding to save their money. It’s because they can’t get loans. They find themselves having to repay the mortgages and the bank loans they took out in times past. So paying off debts – a negation of a negation – is counted as saving.

This is causing debt deflation. It means that instead of spending income on buying goods and services in the “real” production-and-consumption economy, they are paying the bill for past asset price inflation. And this economic shrinkage is raising commercial vacancy rates, threatening commercial as well as residential real estate. This is preventing real estate collateral from recovering, keeping the banks in negative equity. So the Fed has given them tax breaks and cheap credit, and letting them raise their credit-card rates. This is what enabled banks to “earn their way out of insolvency” back in 1980, when America’s anti-usury laws were repealed.

The Fed’s second error is not to realize that the economy is in a liquidity trap. The banks are quite liquid (having swapped nearly $2 trillion of real estate mortgages in “cash for trash” swaps with the Fed over the past two years), but they’re not lending more to U.S. borrowers. U.S. debt is lower today than it was back in 2007 when the bubble was peaking. Banks are not lending against real estate or for corporate takeovers because today’s economy is shrinking. So they are pulling back their credit lines. Instead of finding a market among investors to build new factories and hire more labor, they’re lending to arbitrageurs and other speculators. This money is going abroad. The effect is push up foreign currencies as speculators use U.S. dollar credit to speculate in currencies, to buy foreign bonds and stocks and indeed, foreign assets in general.

U.S. economic diplomats are asking foreign countries not to interfere with this financial gambling and takeover credit. But if countries let their exchange rates be pushed up, this will price their exporters out of the market – and will let their property pass into U.S. hands simply for electronic keyboard bank credit. In a nutshell, it would mean that Brazil, Thailand and other countries would simply commit financial and industrial suicide.

This is pretty much what the Japanese did it after the Plaza Accord in 1985. The United States asked Japan to raise the yen’s exchange rate and lower its interest rate so as to enable the Republicans to keep U.S. interest rates low and do well in the 1986 and 1988 elections. And now, the Fed would like other countries to repeat the Japanese experience.
This cannot easily be done.

The U.S. Treasury and its diplomatic corps are using the same argument that has worked for the past forty years or so. They’re threatening that if other countries don’t agree to follow U.S. policy, the result will be to derange the entire global financial system. Instability will destroy many foreign countries, and in a grab bag the United States usually does pretty well, because it’s economically self-sufficient – at least until quite recently. So U.S. financial diplomats are hoping that the nation’s banks and money managers can make trillions of dollars – $1 trillion, $2 trillion, who knows how many trillions of dollars – until other countries begin push back. And there’s no way of knowing when they will begin to do this, until they actually make a start.

Before they can start, of course, there has to be a plan. And this is just what the BRIC countries – Brazil, Russia, India and China – began to put in place last year at their meetings in Yekaterinburg, Russia. In recent months, Chinese officials have been negotiating currency swap agreements with Turkey, Thailand, Malaysia, Brazil, Venezuela, Nigeria and other countries so that they can conduct their trade in their own currencies, without recourse to the dollar that is declining in value. The aim is to stabilize trade and price relationships, protecting themselves from the financial destabilization that the U.S. is pumping into the world with its irresponsible Casino Capitalist strategy.

E: Let me put up a contrary view that comes from some of the contacts I have in investment banks around the world. It seems they’re all lining up to do a pretty hefty business in supporting trades in other currencies versus the dollar. It is lined up to help the Japanese and Chinese exchange in renminbi and the Europeans to do the same. Maybe this is all a strategy to enable the US banking industry to buy a bunch of foreign assets on the cheap, or maybe it’s just stupidity.

H: I think it is stupidity in the sense that a constraint exists that they’re not realizing. The Chinese have said they would like to see the renminbi become a world currency. The problem is for this or other currencies to become international reserves held by foreign central banks, the issuing nation has to run a balance of payments deficit to pump this currency into the global economy. But China has a payments surplus. So the problem is, how can other countries get enough renminbi to hold in their reserves?

China’s solution is to negotiate swap agreements with foreign governments and their central banks. For starters, this is voluntary, not coercive. Other economies want renminbi, not the dollars of declining value that are flooding in. So in the new post-U.S. international financial order, China will not benefit from the kind of free monetary lunch that the U.S. Treasury has enjoyed. It’s offering an alternative to the predatory U.S. free lunch debt creation. It’s a way of avoiding use of the dollar.

The United States is using its ability to threaten to smash up the global financial system if it doesn’t get its way. Other countries now can point out that if the Fed’s plan is for American banks are trying to make a trillion dollars at their expense, their alternatives is simply to end the dollar’s key-currency role. So when you take this foreign response into account, the Bernanke-Obama strategy involves turning the dollar into a pariah currency, shredding the domestic economy rather than draining foreign economies.

E: So let’s follow this through to understand how some of the foreign creditors to America will respond – oil producers in the Middle East, and even Canada, our largest oil supplier. The last thing they would want to see is the dollar go haywire.

H: The Middle Eastern countries have long felt that they have no choice. After U.S. grain prices quadrupled in 1971, the OPEC countries followed suit with oil. The White House said quite frankly, “We will treat it as an unfriendly act of war if you don’t recycle all your dollars to the United States. You can charge as much as you want for the oil – as long as you invest the revenue in U.S. stocks. Not direct ownership of U.S. firms, but only minority shares in the stock market. This will push up stock prices, and you’ll get even richer.”

Saudi Arabia realizes that it exists only with U.S. support. Doing what U.S. diplomats tell them to do lets them keep their oil resources rather than being treated like Iraq and Iran. It comes down to brute force. So today you don’t have to invade a country to take its economic surplus. You can achieve this financially – or simply with a targeted assassination coup and similar political dirty tricks of the sort that America has played in Ecuador and Honduras and other countries.

E: Well, it seems to me that the currency war is escalating beyond mere words. I didn’t think this would happen for another few years. I’m almost surprised to see it happening at this particular moment. Maybe the idea was to catch us when we were a little weaker and more vulnerable …

H: I think the giveaway to Wall Street is based on politics here at home. This probably couldn’t have happened under a Republican administration, because if the Democrats were the opposition party they would try to stop it. But when they’re in the majority, they will continue to support Obama and his Wall Street appointees who designed this awful policy.

E: I’m working on a ten-year forecast for the U.S. for our subscribers. One of the parts we’re working on is the Output Gap analysis. I know you take a dim view of the validity of this kind of regression analysis, but this came about as a result of an exchange I had with a fellow over at the Washington Post. It’s the kind of analysis you find in the mainstream media now. I’m using it as a tool to gauge what is likely to happen if it actually is driving policy now. I think the general consensus is that we need 400% or greater per year average GDP growth (whatever that means) for the next three years to make up the output gap.

The only time this has happened in history for a three year period or more was during World War II, when we were obviously printing enough money to finance a lot of deficit spending on infrastructure and public programs. During and right after World War II there was more infrastructure spending – and also a housing boom – than any other time, except for the inflationary Vietnam War boom of the late 1970s, from 1976 to 1980. That’s basically it.

So if this kind of inflationary spending and deficits are the drivers for strong growth, you can scratch them off the list today. We’re not going to have another war. We’re not going to turn to a war economy with personal consumption expenditures falling to 50%. We’re not going to sink trillions of dollars invested in infrastructure. That’s pretty apparent.

H: You’re right, we’re going in the opposite direction. We’re going to privatize and sell off the infrastructure. The privatizers are going to increase the tollbooth charges – the access price to the infrastructure they buy. And they are going to privatize it on credit, so the interest and other financial charges and executive salaries will be built into the prices being charged to users, while being counted as a tax-exempt cost of doing business. So the financial sector is backing this – but it will hurt America’s industrial competitiveness, because it will raise the cost of living and doing business all the more.

E: That is how I talked about it in my report, trying to get ahead of that way of doing it. Hopefully we don’t do it that way. But then the final option on this three-item menu of ways to get this 400% plus annual average growth rate is an inflationary boom.

H: There’s a problem with that. Inflation is financed by credit – that is, by going into debt. Every recovery since World War II has taken place at a higher level of debt. The world and the United States’ economy and other countries emerged from World War II with comparatively little private sector debt. There was government debt but not much consumer debt, because there was not much to buy during the war. Not much business debt or real-estate debt either. So peoples’ income was debt free. That means that they had relatively more to spend on goods and services, helping power the postwar boom.

But every new business recovery increased the ratio of debt to national income. So when you look at where inflationary credit is going to come from today, it’s hard to see much more room for growth. In order to inflate the economy, some sector will need to run up more debt. But not many consumers can take on more. And with a third of U.S. real estate reported to be in negative equity, there’s not much room for new mortgage debt here. And companies can’t take on more debt, nor can states and cities because they’re being badly squeezed by falling tax revenues and rising pension plan shortfalls.

E: There are other ways you can create inflation too. Most notably, by manipulating the exchange rate.

H: Yes, that’s how to do it. A dollar outflow of speculative credit will depreciate the currency, and this will sharply increase the price of imports. So the credit that is inflationary is what is being supplied to banks and speculators to play the foreign exchange market and interest-rate arbitrage.

This won’t help the recovery, however. On top of the debt deflation for American consumers, on top of their unemployment and their stagnant wage rates, you’re going to have a sharp increase in import costs, from fuels and raw materials to consumer goods and machinery.

E: You’re seeing a squeeze even for clothing retailers. They have less room to soak up collapsing profit margins, so they’re trying to pass on the import costs. We’re still in a recession, and unemployment is really high. Demand is still weak, and consumer credit is still contracting. But the Fed has put a floor on commodity prices by printing all this money. So the weak dollar is holding oil prices up in the $70 range, even though we’re in this terrible economy. Other commodities also are high. Everyone I know in business has spent that last few years trying to figure out how to deal with the fact that their import costs are high and rising while consumers can’t afford to buy their stuff. So what they’re doing is what you and I can remember from the 1970s: They are shrinking packages, and substituting low-quality imports for higher-quality imports. Meals that used to be all-inclusive now have side dishes that are a la carte. They’re doing whatever they can think of to maintain profit margins in this austerity environment.

H: This is what’s wrong with the Fed’s policy. Its idea of “recovery” is to help the banks – and their major customers are speculators. So in order to help them “earn their way out of negative equity,” the Fed is sacrificing “real” production-and-consumption economy to speculators. Companies that actually use raw materials and consumers that buy products are being squeezed, by a combination of debt service and a financial austerity plan – while Wall Street and speculators are being enabled to make a killing.

The reason they’re making a killing is that the Fed did not write down mortgages and other debts to the ability to pay. The game is to keep the debt overhead in place, not write it down. So the Democrats have been able to serve Wall Street to a much higher degree than Bush and the Republicans ever could have done. They’re saying that the economy can’t recover until they enable Wall Street and the banks to make up the trillions of dollars of bad loans and gambles they made. The rest of the economy will have to pay. So this financial overhead is much worse than taxation – worse than taxes that actually would be spent back into the economy. The Obama administration is willing, even eager to sacrifice the economy to Wall Street. Despite becoming owners of the largest banks, they’re not writing down mortgages, but are foreclosing, raising credit-card rates, fighting tooth and nail against consumer reforms and blocking financial fraud prosecutions.

And to top off their gall, they claim that this is all to protect “the market.” “the market” didn’t have to be subjected to this kind of giveaway or to the Obama Justice Department refusing to prosecute financial fraud, encouraging banks not to renegotiate loans, and not fighting to make Elizabeth Warren’s office independent. This is why so many people that voted for Obama when he promised change are not going to vote Democratic this time around. He really did bring change – but in a much worse direction, more corrosive austerity than has ever existed in this country since the post-Civil War period.

E: Apparently the Japanese ran into a similar political conundrum after their credit bubble burst. They continued to pay off all the debt from the bubble era – but they did manage to engineer it in such a way that wage rates actually increased. From 1999 to 2008 they rose by 30%.

H: The Obama administration’s policy has the effect of lowering real wages by about 30% over the next few years. This is in line with what the American advisors have been urging for Greece and Latvia as a rule of thumb. American real wages just haven’t gone up since 1979. They’ve been stagnant for over thirty years now, and actually have been squeezed when you account for debt service and FICA tax withholding. Now they’re about to go down further. That’s what the Democratic Party is for, much like the British Labour Party. Only they can oversee so unprecedented a squeeze on wages and living standards – and pro-creditor arrangements with a tax shift off the higher wealth brackets onto labor and industry.

E: The new poverty numbers are pretty clear, including the new enrollment in food stamp programs. People can’t afford to meet their basic needs. Their salaries are simply not keeping pace. Yet I keep getting into debates with people who don’t see this is deflation, as a steady erosion of their purchasing power, savings and income.

H: It’s not simply deflation. Unemployment is not deflation as such. It’s a pro-financial anti-labor policy. Take the deregulation of monopoly prices – for instance, letting the cable companies raise their prices, and letting banks increase their credit card fees and late fees. New York City just announced a 17% increase in subway transport fares to take effect in December – mainly so as to avoid taxing property, so that investors and homeowners will be able to pay the banks. Train services and bus lines are being cut back, and some lines are being abandoned altogether. This is basically a FIRE sector (Financial/Insurance/Real Estate) squeeze on the economy.

E: It strikes me that the right blurb to use here is “under-development”. The country is under-developing.

H: It is more a perverse pro-financial bias of development, a malformation – the opposite of what the classical economists hoped to see. This is not “under-development.” It is sacrificing the real economy to the FIRE sector. The derailing of the economy is coming not so much from industrial players as such, because they’ve been turned over to financial managers. The problem is the financial sector gaining control of the economy and replacing the government as central planner. So this is the New Road to Serfdom – to debt serfdom and dependency, much like real European-style serfdom. This is the product of trying to believe Hayek’s anti-government “Road to Serfdom” – that the government is the enemy, that regulation is the enemy, that prosecution of fraud is an interference with “the free market,” and that a “free market” is free for predators, for rentiers to be untaxed, for creditors to be given free reign, freedom from the law and even from having to take losses on their bad gambles. This is a travesty of where Western civilization seemed to be headed half a century ago.

What Hayek didn’t acknowledge was that every economy since the Neolithic has been planned. If the government is disabled, planning passes into the hands of financial managers. And their time frame is short-term hit and run. So right now the financial sector is simply playing for time, trying to keep their bonuses and salaries and bailouts going for as long as they can – and then leaving the economy to sink into austerity.

E: I can explain this best to people who spend some time traveling, because they can see the relative changes at work. It’s hard for many people to remember, but ten years ago when an American went to Europe or Latin America and spent dollars there, and had dinner with somebody who had the same job as you, you were in a favored position. Let’s say you’re an IT professional and worked in the same job in United States as your friend did, say, in Mexico. But your Mexican friend didn’t have the purchasing power that you had. He earned his salary in pesos, while your salary was in dollars. Now fast-forward ten years to today. The average American is getting a lot closer to their counterpart in terms of the quality and quantity of the goods they can purchase in countries that have basically weaker economies. So what I’m observing is that this policy of depreciating the dollar in order to maintain this foreign policy and maintain asset prices is impoverishing people.

H: I just got back from Brazil, and I can attest to the fact that it’s now more expensive to eat there than it is in New York. I usually judge countries’ prices by the price of liquor at the airport. Whiskey is now 25% more expensive in the Brasilia airport than it is in New York City. I’ve never seen so wide a gap. It’s usually more expensive at actual airports anyway, but I’ve never seen it so much so.

These changes are happening very rapidly, although this rapid currency shift almost seems as if the world financial system is being torn apart in slow motion. You’re going to see some quantum leaps and structural changes over the next few months, especially when the G-20 meetings end in a stalemate. Other countries are not willing to commit financial and monetary suicide simply to serve U.S. interests, as Japan did so politely after 1985.

E: Well they sound pretty consistent and pretty clear with their counter-argument to what the United States is demanding. They are operating low-margin businesses that we can’t really afford to here, because (among other things) our housing prices are too high. Even if we could pay these workers a global wage to produce these items, we still prefer to let the Chinese to manufacture them, because their wage rates are lower and they can manage that politically. But now they are saying, “Look, we’re running low-margin industries. Our exporters can’t afford to raise an extra 5% or 10% cut in their dollar-denominated export prices, because they’ll go out of business.

H: So the U.S. is really telling them to commit suicide by letting U.S arbitrageurs and speculators drive down the dollar to make a killing on foreign exchange rates rising. If foreigners have long-term supply contracts denominated in dollars and the dollar’s exchange rate then falls, this wipes out the anticipated revenue of the Chinese exporter.

E: So they’ll go out of business. They’re being pretty straightforward about this. They say that if this happens on a large scale, and for instance we put a tariff on imports (through this currency arrangement that we’re insisting on), they will have massive unemployment and social unrest. This is not good…

H: China already has seen a large rural exodus from the countryside into the cities. It’s difficult to see how this could be reversed. People will not simply go back to the countryside.

E: This has happened after past financial and economic crises. There was a large wave of young people heading back from the cities to the countryside. This created a lot of tension, including ethic tensions. Foreign governments know that this will intensify on a much broader scale if it happens today. But this is too hard for Geithner and these guys to understand.

H: They don’t want to understand. They seem to care only about their own constituency, the large bankers.
Part of the problem of course is cognitive dissonance. To become a financial regulator today, you have to show that you’ve been suitably brainwashed in neoliberalism.

Geithner is simply acting as lobbyist for the big Wall Street firms, which means mainly for Goldman Sachs. They picked him precisely because he is so unimaginative. He has a plan for how everything would work out if everything goes according to “his” plan – not realizing that other countries have their own objectives and can make plans of their own.

There are American strategists who simply think that if there’s an international crisis, it will be a grab-bag, and America will win because it is so self-sufficient. The idea is that if we can create anarchy we usually can come out ahead. In the past we’ve merely had to threaten to wreck the international financial system, and other countries have given in because they believed that we would come out ahead at their expense.

But the geopolitical balance has now changed. And other countries realize that the U.S. view of the world is too simplistic. Geithner thinks of the economy as being like inscribed on a balloon. The shape will remain the same as the balloon gets larger or smaller. But today’s game is not simply about growth or shrinkage. It’s about how to change the rules of the game. What is at issue is the kind of system of international finance the world is going to have for the next generation.

The first result of Geithner’s policy will be to end of the IMF and World Bank, the end of the WTO with its neoliberal austerity philosophy – pro-financial and anti-labor. Thank God that era is ending. China, India, Brazil, other countries are going to create an alternative set of institutions. They’re talking about how to do this in Brazil, in Beijing and in other economies. I can guarantee that they have alternatives being discussed all over Europe and Asia. But there’s not a word being said about these discussions in the U.S. press. It’s as if to discuss alternatives, even to acknowledge that there are alternatives, is to advocate them and somehow be anti-American – which to Geithner means anti-bank.  

E: So you think that we’re going to flip the chessboard over and start the game over again. The last time we did that was in the late 1980’s under Paul Volker. It was the last time we really acted unilaterally. But we were still a net creditor at that time. How can we today, as a net debtor, flip over the chessboard without flipping it over on our own heads?

H: That empire is becoming like Rome, ruling largely by military threat, as it’s shown in the Middle East. We’re muscle-bound – all that we can do is bomb them. So America is what Mao used to call a “paper tiger.” On the rising side of the equation you have China, Russia, India and even Brazil, with Iran invited as an observer to the Shanghai Cooperation Organization meetings in Yekaterinburg, Russia, last summer. The main pro-U.S. groups embracing neoliberal pro-financial policies are Europe’s Social-Democratic and Labour parties. Central Europe is in a death-spiral of economic suicide, as you can see by its austerity programs.  

E: Yes.

H: They’ve cut public spending drastically, from transportation to education and medical care. Imagine that in ten years you find an ad in the New York Times by the Chinese government seeking to attract immigrants from America to work on its railways, in its laundries, to mow lawns, sort through recyclables, harvest rare-earth metals from old computers, work in coal mines, clean swimming pools, and so forth. What a role reversal from the 1880s and 1890s!

E: It would be a pretty disturbing picture for Americans to wind up in a position of subservience to China. But China has some issues of its own. It’s possible that what we’re seeing right now is the end game of a long battle over what the new monetary regime is going to look like. It looks to me as if the United States is holding fewer cards in its hand than it did last time around. The question is whether it’s holding enough cards to come out on top. It actually would be a surprise if the United States could do this again.

H: Well the United States has always imagined that the end game would simply be a return to the past when its diplomats could unilaterally tell the rest of the world what to do. But now we’re seeing the beginning of a new game. And it will not be dictated here, because other countries are more willing to risk an international financial breakdown rather than keep on accepting dollars that the U.S. Treasury has no way of paying, given America’s structural trade deficit, military deficit and capital flight.

So in order to save the U.S. banks from their bad loans, to save them from being prosecuted for fraud, to pay out all the winners on the gambles against A.I.G. and other derivatives traders, Mr. Geithner, Mr. Obama and the rest of this crew are willing to “bet the store” and hope that other countries won’t stop the Treasury-bill standard that has given the U.S. economy so great a free ride ever since it went off gold back in 1971. They’re gambling and losing the pro-U.S. position, and have dissipated all the inertia and good will that enabled U.S. nationalists to say that U.S. consumers and military spending were “the engine of world growth” rather than a free ride.

This intransigent pro-financial attitude is forcing other countries to establish a new financial system – one in which the U.S. dollar – and the U.S. balance-of-payments deficit – will be constrained.

Who could have imagined a century ago that finance would end up destroying the industrial economy and untracking the seemingly inexorable rise living standards? Yet this is what has happened. Politicians and financial managers have been brainwashed. The current managers need to be replaced. The problem is, where are you going to get new people with non-neoliberal views? That’s the way economic students are being taught today.

E: That’s a good question. Where is the next batch of students going to study? Once this mess is over, there will have to be a new regime operating under a new orthodoxy. What’s it going to be? I don’t think it will be socialism.

H: It will have to be a rebalancing in favor of mixed economies. Every successful economy in history has been mixed, with public-private checks and balances. Any market is shaped by government – by taxes, regulations and subsidies, and by public provision of infrastructure either at cost or at subsidized rates, not privatized and financialized to create a tollbooth economy, medieval European-style. I don’t know what the politically favorable term will be for what emerges next. The word “socialism” has been discredited not only by Stalinist Russia but also by the European Social Democrats and Labour parties that have turned into neoliberal pro-financial advocates.

When I grew up, socialism did not mean big government. Marx and Engels were clear about this – in denouncing governments run by the vested interests. Russia had a one-sided bureaucratic collectivist economy under Stalin and became so demoralized that it swung to the other extreme when it let neoliberals turn all the public property over to the kleptocrats – to financialize and sell to foreign investors. This dismantled Russia’s industry, turning it into a raw-materials exporter. This became a travesty of the “post-industrial economy.” It was not even so much a lapse back as an unbalanced destruction that warped its development.

So what will emerge out of this neoliberal “Predator State” as Jamie Galbraith calls it will have to be an economic system with better checks and balances if it is to avoid debt deflation and austerity. It will have to avoid letting banks and creditors do the planning, because their idea of planning is an IMF-style austerity program. You can look to Latvia to see how the future would look if they end up the central planners. There will be a system of mixed public/private sector that does not have finance on top.  It will subordinate finance to industrial investment, agricultural investment and environmental/ecological investments that have not been seen in the past – and probably will have to be run by non-economists until the academic curriculum is revised.

E: We can only hope.

H: Absolutely.

E:  I’ll be interested in seeing how this all turns out. I get the sense this might be one of those issues that escalates and then dies down and then re-escalates. It’s been escalating pretty strongly for the last couple of weeks. There may be some background negotiation going on …

H: There’s been a huge jump in derivatives trade, interest-rate arbitrage and the carry trade. Somebody is going to lose their bets. The question is, who is going to pay and will they be bailed out? If the losers are foreign central banks trying to keep their currencies stable, will they voluntarily take a loss – without asking for compensation from the United States?

E: I guess the way our system works is that if you have the right political connections, you never have to take a loss.

H: That’s right in America. But now, foreign countries can’t afford the austerity that would result from sacrificing their economy to help support U.S. policies – especially when they see these policies as manic junk economics.

E: Fair enough.

H: Okay. It’s been a good discussion.

E: Good to have you on.

Dr. Hudson is a financial economist and historian. He is President of the Institute for the Study of Long-term Economic Trends, a Wall Street financial analyst and Distinguished Research Professor of Economics at the University of Missouri, Kansas City. His 1972 book “Super Imperialism:  The Economic Strategy of American Empire” is a critique of how the United States exploited foreign economies through the IMF and World Bank. He is also author of “Global Fracture: the New International Economic Order,” “America’s Protectionist Takeoff: 1815-1914,” and “Trade, Development and Foreign Debt,” his history of theories of international trade and finance.

Today’s program focused on his current book in progress “The; Fictitious Economy: How Finance is Destroying Industrial Capitalism and Paving a New Road to Serfdom.” Dr. Hudson has been a consultant to foreign governments, including Canada, Mexico and Latvia as well as the United States Government and UNITAER.


[1] Jonathan Wheatley, “Investors calm over Brazil tax rise,” Financial Times, October 6, 2010.