Trade Advantage Replaced by Rent Extraction

I was interviewed on the Renegade Economists radio/ podcast entitled Crony Competition on the road to Unearned Income: Prof Michael Hudson gives a wrap on the economics of 2013 as we discuss Detroit, Iceland, Madoff, Marx and Blackstone Capital.

Why Comparative Advantage was replaced by Rent Extraction – with Prof Michael Hudson by Renegadeeconomists on Mixcloud

Karl Fitzgerald: Our favourite guest, the man that Max Keiser from described as the world’s greatest living economist, yes, Professor Michael Hudson is here to give us a wrap on 2013 and the economic forces that have surrounded us for centuries.

How have you actually seen 2013? What’s played out for you in terms of the big trends?

Michael Hudson: Oh, the same shrinkage that you’ve seen since 2008. We’re still in the backwash; the economy is still unable to pay its debts. The difference in trend is that now you have hedge funds coming in to the real estate market here buying a lot of properties from the banks at great discount prices for all cash.

So, for the last 30 years you’ve had a declining proportion of equity ownership of US real estate. All of a sudden that’s turned around and gone up because you have hedge funds buying for 100% cash. Now that you have Treasury Securities yielding only 1/10th of a percent, the financial sector says “How are you we going to make a higher rate?” The highest rate they can make is in mortgages, so they’re buying the discounted properties and they’re renting them. One of the consequences is that rents are going sharply up for the United States so that not only can people not afford to buy houses now, they can’t get mortgage credit, but they can’t even afford to pay their rent. So the squeeze is on. Only about 25% of workers’ pay cheques here can be spent on goods and services, all the rest is spent on rent and social security, medical care, interest payments and taxes.

Karl: You’re talking there about the growth of rental-backed securities and Blackstone Capital buying up properties at $100million a week from what I’m reading?

Michael: Friends of mine have called and asked me to invest. The problem is, they want $5million at a time and I just don’t have enough money to throw at it otherwise I think that was the best investment around, if I wanted to go around kicking people out of their apartments.

Karl: And that’s really the wash of it isn’t it, is that the one-percenters have got off Scott free, the banking industry’s come up for some criticism, but really there’s been very, very little criticism of the role of land speculation and the whole property Ponzi game. And from that, they’ve just seen it as a go-ahead to develop these rental-backed securities where they can access cheap credit from the markets and just pile in now to not only capture the rents from the mortgage market, but also from the rental market.

Michael: That’s the big change in the last year. Before 2008 you’d have home owners’ mortgages that were being packed and sold and now you have the hedge funds packaging rental properties to absentee owner mortgages that are being sold. That’s the change that’s occurred in the structure of the financial markets this year.

Karl: And meanwhile in America there’s vacancy rates of 10.2%. It’s staggering that people are taking this sort of pain and the Wall Street mob must be just laughing saying “Look, we can push this even further than we expected”?

Michael: That statistic you just cited is way under-reported because the banks are leaving a lot of families in the homes that haven’t paid mortgages in a half-year or a year. They’re not foreclosing because they know that if they do kick the people out of the homes and leave them vacant the homes are going to be stripped of copper, stripped of any wiring and just stripped and the value will go down.

So the banks are leaving people in the homes that are not paying any mortgages just so that they’ll be there and, sort of be the watch guard dogs of the home until they can be picked out and replaced with other people. But nobody sees who’s going to replace them because the economy’s broke.

Karl: Here in Australia we’ve just had our housing finance figures that revealed investors are at 38% of all loans being taken out. It’s shocking how rapidly this is increasing and first home owners are being crunched. They usually average around 19% – 20% of the market, they’re down to 12.6% and in cities like Sydney, the pride and joy of Australia, first home owners are just over 7.5% So we’re being crowded out.

Michael: Yes, what you’re described is inherently unstable. At the peak of the investment boom in the United States in 2008 speculators made up only 1/6th of the market, about 16%. So when you say 38% of Australia, that means people have too much money, to make a long story short. They don’t know where to put it, so they’re putting it there without much thought of how on Earth can Australians ever pay these rents and get jobs where they have to pay so much for their income in rent? How can Australia compete, whether it’s in industry or it’s in services or whatever, how can it compete if people have to pay such a big portion of their pay cheque out for housing?

Karl: So the underlying fundamentals aren’t good. Here in Australia, the jump in part-time workers is the only thing saving the unemployment rate from sky-rocketing and I dare say it’s the same thing in America. But here we have our stock exchanges at record levels, they just keep piling ahead and it all comes down to this quantitative easing, the tapering issue, to taper or not. What are you seeing on the horizon with the tapering?

Michael: Well, whenever they talk about stopping the quantitative easing and letting rates go up, the stock market takes a plunge. So the Fed’s sort of locked itself into a corner. If it does begin to let interest rates rise then stocks and bond prices are going to go down and that’s going to create huge losses for the banks. On the other hand, if it doesn’t let interest rates rise then the pension funds are going broke because they can’t make money by lending out the money.

So here the pension funds are turning their funds over to Wall Street just to gamble. And if you’re going to go broke and you’re a pension fund you think “Okay, I’m gonna default, there’s only one thing to do. I’m gonna take all the money in the fund and I’m going to Las Vegas and I’m gonna put it on the black or the red, 50/50; either I double the money or I’m broke and if I’m broke I’m broke anyway, at least this way I can play for time”. So they’re all gambling and I’m afraid the Wall Street Sharpies are taking their money away.

Karl: Yes, well, we just wonder what is going to be the exit plan there because somewhere along the line they’re going to have to pull the pin on it. More and more countries are starting to question the value of the US dollar.

Michael: In today’s paper there was a report about Madoff’s people, for the Ponzi scheme, and they’re on trial and they were asked in court about in 2006 they begin to think “Something is wrong” and they said “I wonder if Madoff has an exit plan?” And finally they asked him, “Do you have an exit plan in the Ponzi scheme?” and the answer was “No, there’s no exit plan”. When you’re in a scheme that can only crash you don’t have an exit plan; you go on as long as you can and then it crashes. That’s how the game works.

Karl: The wealth gap is expanding at a rate of knots and many commentators, economists are struggling to really get a grip on where this divergence is coming from.

Michael: Yes, it’s coming from the fact that for the 99%, their income’s going down and for the 1% they’re making capital gains and interest. The 1% have the 99% of the population in debt to themselves, so they’re collecting and it’s like a siphon taking all the wealth upwards. And first the 1% are looking for all the income that the 99% have to be pledged to pay the debt and then they want all the assets. So the wealth gap is coming.

For one thing, now people have to pay for their education and that means they have to pay so much they have to borrow, so student debt is increasing and once you graduate you have to spend the next 10 years of your life paying off the student debt. They can’t afford to buy their own homes; they have to live with their parents because if they do buy a home they have to sign away the next 30 years of their life to paying the mortgage. So the entry price to get a job in this society, start a family and getting a home is running into a lifetime of debt to pay the 1%. That’s why the economy’s polarising.

Karl: Is it not also the element of unearned income that’s being bought and sold through property transactions, any sort of buy and sell arbitrage?

Michael: Unearned income sure, if you mean capital gains, riding asset price inflation, financial speculation or just making – unearned income is getting money without working for it, getting money simply by lending money or by owning property and putting up a toll booth and charging people an access price. So the economy is putting up toll booths for education. If you want an education, you have to borrow from the bank. If you want to drive a car on a road, well, we’re putting up toll booths on the roads; we’re turning the roads into toll roads. If you want to park your car, we’re now putting parking meters on the sidewalks and the parking meters’ revenue’s sold off in Chicago to Wall Street for the next 30 or 40 years to get money to pay the interest to Wall Street now.

So the economy’s getting deeper and deeper into debt while all this is occurring. So if you look at the polarisation of wealth, you can just look at the increase in the debt ratio and that’s a mirror image of it.

Karl: You’re on 3CR’s Renegade Economist with your host Karl Fitzgerald and this week it’s Professor Michael Hudson. He’s back on the air giving us the overview of what’s going on with this global economy. Never before have so many handouts been given to those at the top and trickle-down economics is still not working.

And when it comes to ground zero for the failure of public finance, we can go no further than Detroit. The bankruptcy push there is storming ahead and apparently now there’s some sneaky manoeuvres going on with public workers’ pension funds there. It just sounds like an absolute disaster zone. What have you been seeing in Detroit?

Michael: A lot of the pictures are fictitious there. The question is “How do they calculate the pension fund deficit?” and in Detroit the technocrat, Orr, who’s been put in charge of Detroit has more authority than the mayor, the city doesn’t have any authority at all. The technocrat says, “Okay, we’re coming in and if we capitalise the pension shortfall and it all has to be paid in a short period of time then somebody has to lose”.

Now, under normal circumstances, until last week everybody assumed that pensions were a guaranteed contract. They were like deferred wages. Workers in Detroit said “Okay, you can pay us less if we’re a policeman or a fireman, we’d rather play for security and get a pension” and the Michigan State Constitution said that under no circumstances could municipal pensions be cut back. But the judge ruled that under federal bankruptcy only the bond holders are secured. All of a sudden the pensioners are unsecured counterparties and they can receive only pennies in the dollar.

So now, if somebody has to lose the question is, is it going to be the 99% or the 1% – just like your previous question – and in Detroit they say “Only the rich can be paid when somebody has to lose. The workers have to lose, the pensioners have to lose. When there’s no money to go around, the rich get paid first and, if there’s anything left for the 99%, they can get the crumbs”.

Karl: What I see that’s interesting is that around the world we’ve got now these bail-in policies where depositors do come second to creditors, which is a reverse of the bedrock of the financial system. The depositors being first in line created a sense of trust that you would be looked after and now we’re seeing that not even our deposits are safe, so we might as well all just go into debt and join this Ponzi game and speculate wherever we can because savings in this day and age is virtually over?

Michael: That’s not really around the world, that’s in Cyprus and the only reason that was in Cyprus was most of the depositors were Russian.

Karl: In New Zealand this is the case and there are elements of it here in Australia. I’ve heard that in other countries too this is really moving forward.

Michael: Oh, alright, I didn’t know about that. Then indeed, there’s no safety. I don’t know where to put the money. I would imagine people are beginning to buy gold bars. I don’t know what to put it in. In America they’re buying farmland, they’re buying anything that’s tangible that can’t be wiped out.

Karl: Well that’s right. Isn’t it interesting that it comes back to the most trustworthy thing you can have on this planet is land in a prime location that’s productive? And much of what I like to talk about here is the unearned income that can be earned by just owning a piece of property, waiting for society to develop and then being able to sell that.

Now, a lot of people have difficulties understanding the difference between rent and price. Michael, could you give us an outline on what the difference is between rent and price?

Michael: Well, this is what classical value theory was all about for about 800 years, especially from our Quesnay in France, to Adam Smith and Ricardo and John Stuart-Mill. There’s cost value on the one hand and almost all the cost of production, whether it’s machinery or buildings or labour, all the costs can be reduced to labour. However, if there’s a price that’s higher than the cost of production that difference is called economic rent. So that’s why people talk about rent extraction in these days.

For instance, in America about a century ago, unlike other countries, we left the electric utilities, gas companies, power utilities in private hands, like the railroads were here, and so the government developed a way of analysing what is a fair price for utilities to charge for gas, electricity, for railroads, and so it was all based on actual cost of production. The idea was you want to get rid of monopoly pricing. A monopoly pricing economic rent, monopoly rent, is when a company charges more than the cost of production, including normal profits, will reflect. And traditionally you have that in land, in real estate, in mineral rights, in finance when banks can create money on their computer keyboard freely and then lend it out to get interest.

So rent and interest are created without any real cost of production, they’re simply a result of a legal privilege, whether it’s a legal privilege to erect a toll booth or to somehow impose a tariff or a special monopoly price gouging.

Karl: And what is the cause of this market power that gives them the ability to enforce these higher prices?

Michael: Usually, the failure of the government to apply anti-monopoly laws. Until Margaret Thatcher’s time, Europe kept its roads, its railroads, its airlines, its gas and power utilities in the public hands. So the whole idea was that basic needs and infrastructure would be supplied to the private sector economy either at cost or at a subsidised price so that you’d made the economy more competitive. If you have to begin selling off the roads and putting toll booths there and people have to pay more for that; if you begin selling off land or real estate and the value goes up and you build public infrastructure and you don’t tax it away then all this rent is going to be capitalised into a bank loan and the house is going to cost much more and you’re going to increase the cost of living, and if you increase the cost of living, that’ll increase the cost of labour and it’ll make countries uncompetitive.

So right now you have Thatcherism and neo-Liberalism spreading throughout the world. Every country is trying to be as uncompetitive and high cost than the other country because being high cost means that somebody can borrow money against it and leave somebody else holding the bag.

Karl: So that’s why trade theory in comparative advantage has really gone out the window due to this financialisation of the economy?

Michael: Yes, if you have three-quarters of the American budget going for housing, either rent or a mortgage, and for debt service and for taxes and medical care, then you no longer have the price of grain or the price of bread determining the price of labour as it did in Ricardo’s day. You have really a financialisation of everybody’s income and it’s a rent theory of international trade instead of a cost of production theory of international trade competitiveness.

Karl: And it is bizarre when you look at the privatisation arguments that are going on around the world, it’s almost as if economies of scale have been superseded by crony competition?

Michael: It affects the markets, that’s right. The whole idea now of economies of scale means the ability to control the market and extort economic rent higher than the cost of production and get a free lunch. So today’s economy is all about getting a free lunch. This is exactly the opposite of everything that the classical economists thought they were pressing for.

Karl: Now, back in the mid-1850s there was a lot of talk about this issue of unearned income, of rent theory and being able to enforce your monopoly privileges on society. I’ve seen you write a lot about the physiocrats, John Stuart Mill, David Ricardo, Malthus and, of course, the great man, Henry George. But someone who I haven’t really seen you write much about said the following quote: “One section of society exacts from another a tribute for the permission of inhabiting the Earth. Private property in land implies the privilege of the landlord to exploit the body of the globe, the boughs of the Earth, the air and with them the conservation and development of life”. Now, that was Karl Marx in Das Kapital Volume III on page 898.

Why haven’t we heard more about you on Karl Marx talking about unearned income, because really we need people to understand just how widespread this knowledge was back in that day and age?

Michael: Well, in my book The Bubble & Beyond I have a whole discussion of Marx’s Volume III. And basically he went on from the quote that you’re saying to say that now there’s been a change in all of this; now property’s being democratised, now everybody’s able to buy their property on credit and so on the landlord’s back there’s the banker. So it’s true that in the foundation of industrial capitalism that Marx was driving people off the land into the cities where they had to work for wages, but now the real estate owners pay all the rent to the bankers so it’s the bankers that end up with the bounty.

Now, Marx is of two minds and when you remember he didn’t live to complete Volume III, all we have are his notebooks that he was going to write and there are two different strands in his notebooks. On the one hand he’s going to say “Look, it’s the role of industrial capitalism to make banking productive and to industrialise banking and to make banking finance industry”. On the other hand, he collected all the quotations he could from all the earlier writers saying “Look, you have compound interest, you have banks being fraudulent, rip-offs, look at the Panama Canal fraud, look at all of the big frauds the banks are involved in”.

So the big question that he never lived to answer and, given when he died in the 1880s there wasn’t time to answer it yet, was banking going to be subordinated to serve industry or was industry going to be essentially starved to finance banking? And that’s basically what I wrote about Marx there, but certainly Marx’s theories on surplus value, which he planned to be the first volume of Capital, it was the first history of economic thought and in that he summarised what all of the economists of his day – from William Petty onwards – had been writing about, land rent and interest and the whole evolution of rent, interest and wages.

So I think that if one’s going to analyse any economy such as today the best way to start is with the history of economic thought to get the concepts of value, price and rent. That’s really the key to analysing anything and that’s what’s missing in the economic education today.

Karl: So Iceland has been lauded as one of the few nations to really take on the banking elite and recently they’ve engaged in some sort of mortgage write-down where all mortgage holders have been given $30,000-odd each to pay off their mortgage. How have you seen that policy Michael?

Michael: Iceland’s in a mess because it hasn’t taken on the banks. The pension funds in Iceland have a lot of their money invested in the banks and Iceland has probably the worst kind of creditor rule that you’ll find in any country. The amount of debt that’s owed on a home or a mortgage is linked to the consumer price index. Well, in Iceland, because mainly all they produce is fish and aluminium, the prices are set by imports. So when the banking crisis led to the currency devaluation, all of a sudden all the prices went up and if you bought a home with a mortgage of kr100,000 now all of a sudden you owed kr180,000. So what they’ve done is just tried to cancel some of this bizarre increase in the price adjustment of the debt. There’s nothing like that in Australia or the United States. It’s unconstitutional in Iceland but the banks are still running the country, or at least they were under the Social Democrats and the Green Party that essentially were the bank lobbyists in power.

So, nobody knows what’s really happening in Iceland now. The banks have so much money that Iceland can’t afford to make the currency convertible so it has a blocked currency. If you’re in Iceland, you can’t transfer your funds abroad. The banks have so much money that they’d like to send abroad that if there was a free capital market, like in other countries, the currency would fall another 90% or so. So, nobody has a clue as to how they’re going to get out of that situation, unless it’s a total write-down of debt.

Karl: They’ve certainly arrested bankers, they’ve re-written their constitution. They’ve tried so much, but they haven’t got these fundamental economic principles in order and from that I see it as a great tragedy in Iceland that, according to their Statistics Bureau, property prices have increased 35% since 2008. So they’re back on the bubble agenda again and by writing off this mortgage debt it’s only going to encourage people to go and borrow more money to push up the price of real estate yet again.

Michael: No, the prices are still way down from before. All this was a sort of bounce from the distress sales and it’s very hard to borrow money in Iceland for a house if you’re already in negative equity. So, I don’t think you can look at Iceland and assume that it’s like Australia or the United States. It’s a uniquely financially distressed economy and the newspapers are not giving the whole story because to explain the whole story would take more space than the average newspaper has.

Karl: So what nation do you see is moving in the right direction in terms of economic policy? Is there any nation, Michael?

Michael: I can’t think of anyone particular. All you can say is who’s avoiding the problems? China seems to be avoiding the problems for the time being. Everybody else, the Eurozone is a dead zone, they’re not doing very much; the US is in the doldrums; the Third World is now in trouble, especially India; Russia hasn’t really rebuilt its manufacturing base. The whole world is sort of falling apart.

Karl: As Blackstone Capital and crew build up their easy finances to roam through Spain and snap up all sorts of distressed properties there. I mean, you’re just starting to see these heat maps of the properties Blackstone are buying up. There’s been some great articles on Truthout about it and, gee whizz, it’s heading back to the neo-feudal era more rapidly than I would have thought, Michael. I mean, you’ve been talking about this concept for a while, did you think we’d be moving this fast into the rent extraction reality?

Michael: It always moves this fast. Every business cycle for the last 200 years, you have a slow upsweep and then a sudden drop, slow upsweep and a sudden drop. So it’s not really a cycle like a sine wave, it’s a ratchet up and down, so all of the declines are fast. And now, as any Wall Streeter knows, it’s easier to make money in a distressed situation than it is in a healthy growth situation. And that’s what you’re seeing now; you’re seeing Blackstone pick up distressed properties.

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