Interview with Michael Hudson
lnp3 at panix.com
Sat Jul 12 15:16:17 MDT 2003
Counterpunch, July 11, 2003
An Interview with Economist Michael Hudson
The Coming Financial Reality
By STANDARD SCHAEFER
The war in Iraq is allegedly over, interest rates are going lower and there
are rumors of recovery although the economy is still in the doldrums. A
Bush is president, but an election is around the corner. It sounds a bit
like the recession of 1990-1991. In fact, the recovery from that period,
anemic as it was marked by very little growth in employment--was actually
stronger than this one. The US economy grew at an annual rate of 3.1%
compared to the 2.6% annual rate currently. Except for the 1992 recovery,
the last seven economic recoveries were much stronger than this one, and
each of them, corresponded with the usual amounts of job creation. So far,
the current unemployment rate has actually edged higher to 6.4%, and among
African-Americans is twice as high. Meanwhile the mainstream financial
press has been arguing that the virtue of "jobless recoveries" is even
higher rates of profitability for corporations.
Generally echoing the jingoism of the general media, financial publications
such as The Wall Street Journal, The Economist and Business Week have
chosen to highlight the job growth in one sector-services. The refinancing
boom, as they argue, contributes to the service sector by promoting the
retail industries: lower mortgage payments mean more money for consumer
goods. But, in this case, it also means all-time high rates of consumer
debt. The Federal Reserve continues to exacerbate this problem, most
recently by dropping rates once again, ostensibly to stave off deflation.
The financial press celebrated the move by hyping the stock market. Little
attention was paid to the fact the Fed itself admitted that the main reason
for the rate cut was that the economy "has yet to exhibit sustainable growth."
Meanwhile, the 2003 federal budget--thanks in part to Bush's war and his
reckless tax cuts-is expected to approach a $500 billion shortfall this
year. In comparison, Clinton's tax increases were almost progressive. His
deficit reduction and spending restraint kept interest rates low and
spurred the investment boom. Capital gains taxes from investment played a
major role in creating the $236 billion budget surplus in 2000. Today,
however, those taxes have been cut, along with dividend taxes and the
massive federal deficit has begun to wreak havoc on the states' budgets.
California's $38 billion shortfall is a nationwide all-time record.
Thirty-eight other states are in situations nearly as dire. This, of
course, means there will be huge layoffs in the public sector. And
unemployment means no pricing power for labor, no wages to pay off debts
accrued during the bubble, a potential wage of foreclosures and a resulting
set off layoffs in the service sector.
On July 1st, as the state legislatures began their new fiscal year, I spoke
with Leon Trotsky's godson, heterodox economist and historian Michael
Hudson, one of the few with both real experience inside the financial
services sector. He believes that it is not enough to know that
corporations will do everything imaginable to extract profit at the expense
of the workforce. It is not enough to know that politicians represent their
donors, not the electorate. He believes you also need to have some
background in the financial system as a whole to understand where the
economy is headed and why "free market" propaganda dominates the terms of
debate, despite all the evidence of its failings.
Professor Hudson is presently writing a book on the bubble, focusing on the
increasing dominance of the financial industry over industrial production.
I asked him to relate his ideas to the coming state of social security,
employment, Bush's war against the poor and the middle-class, and the
international ramifications of US economic policy.
The downside of low interest rates
Standard Schaefer: Let's start with the economy in general. Today's
interest rates are the lowest since the1958 recession, but the economy is
essentially stagnant. What is your take on the Federal Reserve's interest
Michael Hudson: The first effect of these low rates is to benefit the
banks. That's the aim of central bankers today. Whether it benefits the
economy at large is another matter.
The banking system's cost of obtaining funds is now almost as low as it was
after World War II. But long-term rates for mortgages and credit cards have
not fallen. So the lending margins of banks have widened, increasing their
earnings. This is why we don't face a Japanese-style bank collapse. U.S.
banks have managed to avoid bearing the brunt of the stock-market losses by
passing their bad stock investments and bad debts on to their customers,
the pension funds and mutual funds. Labor and its savings have borne the
brunt of the post-2000 market downturn. It's the people who put their trust
in banks and other financial managers that are on the short end of the stick.
The rates that have responded most significantly to lower borrowing costs
are short-term loans for financial speculation, above all for derivatives
and related buying or selling of stocks and bonds on margin--enormous
gambles on which way the dollar, the stock market and interest rates may
go. This kind of lending does not help the economy invest more in fixed
capital formation. It merely helps create a thriving and profitable new
Like Japan, the U.S. economy has painted itself into a debt corner that is
locking in low interest rates. These rates can't go up without causing
widespread distress. This "lock-in" is a second effect of the Fed's policy.
As interest rates have fallen, home owners and businesses have found their
income able to support a larger debt pyramid. A thousand dollars per month
can carry twice as high an interest-only loan at 5% as it can at 10%.
Instead of using the decline in interest rates as an opportunity to pay
down their debt, they have borrowed more. Mr. Greenspan has encouraged them
to do this so that they can go out and spend more money, creating more
profits for producers of the goods they buy. This is the first time in
history an economic planner has advised people that they can live better
and the economy can grow faster by running deeper into debt. This
philosophy blatantly serves the commercial banks and other lenders and
savers rather than keeping their self-interest in check as government
financial policy would be doing in a better-run economy.
Most of America's new debt creation represents floating-rate mortgages.
Their interest charges may rise if general interest rates increase. This
will enable banks to pay their depositors rising rates, thereby holding
onto these deposits rather than seeing the scale of withdrawals that killed
the savings and loan associations (S&Ls) in the 1980s.
However, if and when interest rates rise, carrying charges on most peoples'
debts will jump sharply, especially for real estate. Some people and
companies that have borrowed to the hilt will default, and be forced to
sell their assets. Prices for real estate and stocks will fall, and many
debtors may find themselves with negative equity in the property they have
bought. By negative equity, I mean that the price of their home may fall to
less than they owe on the mortgage.
The very thought of this scenario happening will deter U.S. planners from
increasing interest rates in the foreseeable future because of the problems
this would cause. But just as high interest rates caused problems in the
past, low rates may cause a new kind of problem for the future.
A good example is the effect that low interest rates are having on
corporate pension funds and other personal savings. Companies with "defined
benefit plans" are obliged contractually to set aside earnings in a special
fund that will generate enough interest, dividends or capital gains to be
paid out to a growing number of retirees. Rather than paying these pensions
out of current income as it is earned or plowing their earnings back into
investment in their own business, companies take their income and
"financialize" it by buying stocks and bonds for their pension funds.
As interest rates fall toward zero, however, an infinite amount of savings
is required to produce interest income. This is the basic folly of not
simply paying pensions on a pay-as-you-go policy in the way that Germany
has done. As interest rates fall, companies need to set aside more and more
of their net cash flow for their pension plans. And at today's interest
rates, almost all their earnings are absorbed by pension-fund commitments.
This problem is as serious in Britain and other countries as it is in the
This phenomenon has a number of effects. First of all, reported company
earnings will fall after netting out pension-plan contributions. This is
not good for the stock market, and makes it even harder for companies to
pay pensions out of capital gains they hope to make.
To avoid this problem, companies are abandoning their "defined benefit
plans" for "defined contribution" plans. The change in wording (from
"benefit" to "contribution") means that instead of getting a promised
stream of benefits upon their retirement, employees will have a specific
amount withheld from each paycheck. In effect they are told that their
employers don't have any real idea as to how much these workers are going
to get upon retirement. Only the top executives have worked out golden
parachute packages with stipulated payouts.
Companies also are firing workers just before they become fully vested in
their pensions. This cheats them out of what they had expected and indeed,
deserved. But a simpler way to wipe out corporate pension commitments is to
merge with another firm or allow oneself to be raided, under terms that the
new company changes the pension rules. The raiders empty out the pension
funds and uses them for their own purposes, partly to pay off their
financial backers and partly to pay bonuses to their leading officers out
of the savings they have expropriated from the employees.
This is what Dick Cheney did at Halliburton with one of the companies it
absorbed, attesting to the support this anti-labor stratagem has at the
highest levels of our government.
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