Geithner Turfed Out by EU Bankers

Prof Hudson appears on the Renegade Economists radio show to discuss the economic growth trap, compound interest, Sumeria, the corruption of economics and how US interests are flexing in the debate over what constitutes a CDO default in the EU. This interview was conducted just days before Greece was given another reprieve.

Recorded March 7th

Listen to the interview recorded March 7th.


MH: Prof Michael Hudson, Distinguished Research Professor at the University of Missouri-Kansas City.
KF: Karl Fitzgerald

KF: Professor Michael Hudson, welcome back to the show! Our listeners certainly appreciate your time. Can you explain to us why economic growth is necessary?

MH: Well for one thing, populations grow and so you have to provide more goods and services. For another thing, people expect to have rising living standards. As long as technology is increasing productivity, people think it is fair that some of this productivity should be passed on to the workers and the population as a whole, rather than what occurs in the United States for the last 30 years, where almost of the productivity growth has been siphoned off by the financial sector, which causes great inequality as sucked up to the top of the pyramid and the bottom of the pyramid is impoverished.

You need growth in order to raise up the parts of the economy and the population that are less educated or less productive. You have to keep your economy growing to keep up with other countries that are introducing better technologies so that you do not fall behind and become dependent on them. So there are social welfare reasons and national security reasons, and the basic internal dynamic is that if you are going to have an economy that has to pay interest, you are going to have to have the economy grow by at least enough to carry its debts, otherwise there are going to be insolvencies and foreclosures and the kind of economy you have in the United States, Greece or Latvia.

KF: So how much of this growth mantra is reliant upon the ever-expanding money supply?

MH: By the money supply you really mean debt supply. You are making the difference in principle between the growth of financial wealth – the value of stocks, bonds and real estate – and the growth of productive capacity and real wealth. These two terms are very often used interchangeably, so that it is the money that increases the volume of debt – because money is debt – and the debt becomes parasitic and actually stifles growth. So if you have one kind of growth – booming financial fortunes in the stock market, higher real-estate prices and more expensive means of living – then you are going to have slower growth in the real economy because money is diverted from peoples’ pay-checks away from buying goods and services to just having to pay the banks.

KF: What about the role of compound interest?

MH: Well that’s the problem – compound interest keeps doubling and redoubling. Any interest rate is a doubling time. If you take the number 72, for instance, and take any given rate of interest – 5%, 6% or 7% – and you divide 72 by this number, you will get the number of years that it takes for a given amount of savings to double.

The fact is that no economy in history has ever grown as fast as its debts have grown. And that is why business cycles slow down – as debts grow faster than outputs, more and more money is diverted away from spending on goods and services, there is less direct investment, less new hiring and increased vacancies, and people have to pay more to the financial sector and that turns out to be a means of stifling growth.

KF: Can you outline when compound interest came into play and what some of the forces were behind it?

MH: It is first documented clearly in around 2400BC when the Sumerian city of Lagash went to war with Umma and it is said that Umma had to pay reparations at the going interest rate, which was one shekel per mina per month, which works out at 20% per year. The calculation ran into the millions of bushels of grain that Umma owed, and so Sumer erected a stone on the boundary between Lagash and Umma saying “You owe us this much money, and if you do not pay it we are going to go to war.” So the first compound interest on record was money owed by a city as war reparations to the victor.

KF: Surprise, surprise. And did that become a commonplace event from that point on?

MH: Yes – the scribes, who were the intellectuals (the people who wrote cuneiform in Sumer) wrote textbooks and we have the textbooks that they taught. What I’m amazed to find out is that the textbooks and the economic models that were taught in 2000BC are superior to any of the models – the mathematics – that win Nobel prizes today. The Sumerians were very clear on what the mathematics were, and they are easy enough that any high-school student can understand them. The Sumerians said “How long does it take one mina to double at the rate of 20% per year?” – and the answer is 5 years. Now no economy can grow that fast, and in fact the Sumerians and Babylonians also had mathematical models for how fast herds grow and other activities grow, and these are S-curves. So the real economy grows in an S curve, but exponential compound interest keeps on growing until the debts exceed the amount that can be paid. This became very clear to the Sumerians and, realizing this, when a new Sumerian, Babylonian or other near-Eastern ruler would celebrate the first year on the throne, they would cancel all of the consumer debts so that they could begin with a clean slate. They would liberate the bond-servants who had been pledged for debts and they would return the land, or the crop rights, to the families that had forfeited them to foreclosing creditors. The whole economy could start with everybody able to support themselves. Having land was a condition for being able to fight in the army and defend the country against other city states that were trying to invade it, so the idea of a clean slate was for military reasons as well for social justice and plain economic logic.

KF: So why have we been conned into believing that compound interest is a legitimate banking operation, and can you explain that within the realm of the social contract and the privilege of creating money or debt that bankers have?

MH: About a hundred years ago, the financial sector joined with the landlords in being the major donors to the business schools and also the major donors to the political campaigns, and they sponsored economics departments and the mass media to tell people that all of the debts could be paid and that economies automatically settled down to equilibrium, and as the Chicago school of monetarists said, debts do not really matter because we owe it all to ourselves.

Well, when someone says that an economy owes all the debts to itself, what they really mean is that 99% of the population owe the debts to 1% of the population. The financial sector has turned what used to be classical political economy into what really is junk economics, in which the real economic problems that we have today cannot exist in principle. Reality cannot exist according to the textbooks!

Instead what they teach students is a kind of happy-faced science fiction story, where everybody can pay the debts and everybody earns whatever they get. Classical economics was all based, for 800 years, on the principle that there is such a thing as unearned income – land rents, interest and monopoly rents all were not earned; they were the result of privilege. But the reaction against classical economics said “Everybody earns exactly what get.” So the national income accounts and product accounts that the governments publish all say that whatever the financial sector earns is providing a service of collecting the debt. Landlords provide a service by providing the land (that nature already provided, but somehow they interjected themselves right in between). One no longer hears words like rentier, or unearned income or unearned increment. And yet this is what 19th-century classical economics is all about, from the physiocrats to Adam Smith to John Stuart Mill.

KF: Can you explain then how this unreality in the financial sector has grown into this monstrous derivatives bubble?

MH: Well an unrealistic theory has real-world consequences. If people follow a false map, then they are acting in reality but the map is unrealistic. So what you have is that banks, instead of making money by lending money and collecting interest, have turned finance into what is called casino capitalism, and banks let people bet on which way interest rates will go (these are called forward options), or which way foreign exchange will go – so you can bet that the Australian dollar will go up or down against the US dollar. And all of a sudden you have turned the financial market into a kind of horse race or casino and people can bet enormous amounts on which way capital markets will go. None of these bets actually fund industrial investment or tangible investment. So we are brought back to the first point that you made at the beginning of the show, saying “What is wealth?” Is it the real means of production and consumption, or is it all the counters that the gamblers win in the derivatives casino on Wall Street?

KF: What is the big play going on between US banks and the euro in the world of shorting, and can you explain what shorting is?

MH: Shorting is when you promise to deliver a stock or a security or a bond at a given price. For instance, you can say “I will sell you a Greek bond that is 50 cents on the dollar.” That means that if the price of Greek bonds plunges and they default, you can buy them at 25 cents on the dollar and sell them at 50 cents on the dollar and make a mark-up. The way this plays out between America and Greece is that apparently, a few months ago, Europe had told Greece that Greece would have to write down the debts to about 25 cents on the dollar. The US Treasury Secretary, Timothy Geithner, went over to Europe and said that our US banks believed that Europe would bail out Greece and lend it the money to pay, so they have all made counter-parties to bet that Greece is going to pay 100 cents on the dollar. And your banks in Greece and France and Germany have all taken out insurance – they have bet that the price will go down, so if Greece defaults, we Americans are going to have to pay maybe $50 billion on losing bets. We would like you to please do what Europeans are supposed to do – will you commit financial suicide and will your leaders support the US banks against your own banks so that we will not lose money? Otherwise we will make sure that you do not win elections because we will pour American money into your opponents and we will put in a puppet government that does whatever we want. So it is your money or your life – you had better do what America tells you to do and bail out Greece. Well, I was told by German bankers that they told them, “Get the hell out of here!” And the result is that Greece is probably going to default in two days. So Mr Geithner said, “Look, if we go under, I’m going to make sure that we are really going to do everything we can to hurt you, but I’ll give you the money – we at the Federal Reserve will just print tens of billions of dollars and we will give you the money to bail out Greece at US taxpayers’ expense so that our main campaign contributors, the Wall Street banks, will not lose money.” So in other words you have the Obama administration and the Secretary of the Treasury, loading down the American taxpayers with debt in order for yet another give-away for the banks that have made really bad judgments, and they are trying to make Europe lose too. Today in America, the stock markets fell 200 points on the Dow Jones Average because they realized that the game is up and this rip-off is going to stop, and the Obama administration has just shamefully tried to double-cross the electorate to Wall Street, its campaign backers, yet again.

KF: Why is this going to happen in two days? I would have thought it might have happened closer to the end of the financial year for the banking sector to perhaps write off some of these losses.

MH: Because in two days, Greece sends out a tender asking all the banks that hold its bonds to save the American gamblers from losing by saying “Will you voluntarily write down the debts by 75%? Will you lose three-quarters of your money voluntarily so that the American banks won’t get angry and come over and shoot us?” That was the word used by the German bankers, that Americans will shoot them. They are afraid for their life – that is the real war going on and it frightens them. So the Greeks said, “Look, if you don’t voluntarily write down the bonds that we cannot pay to 25 cents on the dollar, we are going to announce that we are in default.” That happens on Thursday, and if that is in default, then all of the American casinos that have guaranteed against default are going to have to pay the German banks, the French banks, the Greek banks and the other European banks 100 cents on the dollar because that is what these banks have paid for – that is what a derivative and an insurance policy, or a credit default swap is, it is a guarantee. Like most American and British insurance companies, Wall Street does not want to pay. We have had pretty much a criminalization of the financial markets here in the United States, and actually, there has been a Nobel prize given to Akerlof for describing the financial sector as a criminalized sector, and that was an economics prize. So it is pretty much recognized in academia that Wall Street is corrupt, but this is not played up so much in the newspapers.

KF: So you have recently been in Germany and Italy and you had some private meetings with bankers – you are always called in as an adviser – is that where you found out this information on Geithner?

MH: Yes, from Frankfurt.

KF: What is your opinion about the role of the International Swaps and Derivatives Association, the ISDA, and their role in determining the definition of a default and how that would play out in the shorting swindle?

MH: Well for the last month there has been a decision – “Wait a minute – if Greece says ‘We cannot pay, will you lose 75% of your investment?’ is that really voluntary, or is it not voluntary?” Essentially they are saying to the banks, “Look, either you take 25 cents on the dollar, or you do not get anything.” That is what they said yesterday – that banks not exchanging their bonds will not get anything. This becomes a semantic issue – is this a default, or not? The ISDA is the official body deciding whether or not this a default. It is like the Oxford English Dictionary deciding whether a term is an English language word or not. They are deciding whether this is a default or not. US credit rating agencies like Standard and Poor, Moody’s and Fitch have already rated Greek bonds as junk. The trading on the derivatives market is already assuming that they are junk and that they will not get paid. And the question is, will the ISDA, made up of the large banks, decide that there is or is not a default. Well, obviously, banks that have taken out insurance will want to say “Yes, there is a default, we want to get paid.” And the insurance banks say, “No, no, no, there is no default, we do not have to pay.” So there is quite a bit of self-interest in this semantic determination of what is a default.

KF: Professor Hudson, you were recently in Italy, can you explain how and why you came to be there?

MH: Over 2100 Italians – regular, middle-class and working-class people all put up money, enough to bring four of us from the University of Missouri-Kansas City over. They brought me, the department chairman, Professor Bill Black and one of our bloggers, Marshall Auerbach, along with a Frenchman, Alan Parquez[?] to explain modern monetary theory to them and why Europe’s austerity is not necessary. What Europe needs is a kind of central bank, just as the United States, England and Australia have, that actually will fund and finance government deficits. The European Union pretends that it is wrong for a central bank to finance the government deficit. Rather than creating interest-free money, like other countries do, they force governments to borrow money from the banks at interest. This creates a lucrative market for the banks, but it forces the economy into depression because if the government does not run a deficit and build up its debt, then in a recession there is not going to be enough demand and purchasing power for the private sector to grow. So the European Union, the eurozone, is imposing austerity, suffering, poverty, bankruptcy, emigration and foreclosures on its populations needlessly. The Italians who brought us over said “Look, they are telling us that there is no alternative, that you have to give all the money to the rich, that you have to un-tax real-estate, that you have to untax wealth and you have to shift the taxes onto labor, that you need more unemployment and that this is a fact of nature. Is there an alternative?” And we were brought over to show them that, yes, there is an alternative. What they are doing in Europe is turning over central planning to the banks. Europe is more of a planned economy today than the Soviet Union was, in many ways, but the difference is that instead of being planned by government bureaucrats, it is planned by the bankers and the insurance companies. And if any of you have had to deal with an insurance company or a bank if you have had a complaint, you know what the problem is. As Professor Black pointed out, the behavior of economies run by banks is just as criminogenic as you had under Stalinism or centralized economies of that sort. That is what Europe is looting for – a corporatized, centrally-planned economy in the hands of bankers whose philosophy of growth is “We want your money.” The 1% wants whatever the 99% have, and they are going to force governments to borrow, families to borrow, they are going to charge for education and, especially, they are demanding that Greece privatizes its infrastructure so that new buyers can borrow the money and buy ports, sewer systems, water systems, land and real estate, and charge excess fees for these and turn Greece into a set of toll booths, and make a toll booth economy. That is what they call a free market – it is free for the landlords, free for the privatizers and free for finance to grab whatever they want from the rest of the economy. It is their freedom to reduce the rest of the economy to neo-serfdom and neo-feudalism.

KF: So in effect, monopoly is the new norm?

MH: That is what is called a free market in the European textbooks.

KF: Taxes since the great recession have not really switched onto labor through income taxes but they have through sales taxes. Can you discuss how that system is gamed by the upper echelons, because that is usually the argument, that the black market cannot avoid a sales tax and we cannot hide our money in a tax haven either.

MH: Well, of course, money can be held in tax havens and the European Union calculates that of the €50 billion that Greece owes, €45 billion is stashed away by wealthy people in Swiss banks alone, so of course the taxes can be avoided. The idea is that sales taxes are easy to collect. But the question is, what are you going to have? A tax system that is easy to administer, or a tax system that makes sense and has the economy grow. If you have a sales tax on consumer goods, then prices are going to go up. If you have income taxes on labor, the cost of labor and living costs go up. If you have a tax on, say, land, then you are going to have the price of houses and real estate come down, because there will be less land rent available to pledge to the banks to take out a loan again.

KF: That is what people do not get, though, they do not understand how a land tax fores land prices down.

MH: Well, this was the center of what classical economics is all about. And it’s amazing – a hundred years ago, people understood this fairly well by just studying rent theory. But rent theory has been dropped from the curriculum now, and people talk about ways that they can profit, but they do not talk about rent – economic rent –, which is what economists described as unearned income. It is income that does not have any corresponding cost of production, that is purely the result of privilege, and is price in excess of cost value. Now let us say that you have a property that rents out for, say, a million pounds per year. Somebody can say, “I am going to buy this big office building, and I am going to pay a million pounds to the bank and if they make a loan at, say, 5%, then I can borrow £20 million against it. But if half of the value of real estate is land and half is the buildings, the government can say, “Look, nature provides the land, and we increase the value of that by all of the public investment on infrastructure, transportation, electrification, roads, etc., so we are going to tax this £1 million rent that you get by £500,000 each year”. So the other £500,000 will represent the value of the building, and the landlord then can say, “OK, I can still borrow at 5% interest, and that means I can borrow £10 million against this but not £20 million,” – you can only borrow half as much. A property is worth whatever a bank will lend, and if a bank will not lend as much of a mortgage, then the price will be much lower. So the more that a government cuts the land tax, the more rent is available to be paid to the banks in the form of a loan. Now, people are going to pay the same rent, anyway – rent is set by the marketplace. It is set by location, where people want to live, how they want to define their status, or, in America, what schooling and public education is available near there. But the question is, how much of this is actually necessary to compensate for what it has cost to build the building, and how much of it really belongs to the public sector? Well, the situation gets even worse when you cut the tax on land, because if you cut the tax on land, then the government has to tax labor, or consumer goods through the sales tax as you mentioned, or capital by income taxation, and prices go up elsewhere. So the way to un-squeeze labor and industry, and to lower the cost of living and lower the cost of production is by a tax on rent – that is what classical economics was all about.

KF: Professor Hudson, thanks very much for joining us here on the Renegades.