|The "New Austerity" Road
by Michael Hudson
EUROPE IS COMMITTING fiscal suicide - and will have little trouble finding
allies at this weekend's G-20 meetings in Toronto. Despite the deepening
Great Recession threatening to bring on outright depression, European
Central Bank (ECB) president Jean-Claude Trichet and prime ministers from
Britain's David Cameron to Greece's George Papandreou (president of the
Socialist International) and Canada's host, Conservative Premier Stephen
Harper, are calling for cutbacks in public spending.
The United States is playing an ambiguous role. The Obama Administration
is all for slashing Social Security and pensions, euphemized as "balancing
the budget". Wall Street is demanding "realistic" write-downs of state and
local pensions in keeping with the "ability to pay" (that is, to pay
without taxing real estate, finance or the upper income brackets). These
local pensions have been left unfunded so that communities can cut real
estate taxes, enabling site-rental values to be pledged to the banks of
interest. There is no way that any mathematical model can come up with a
means of paying them. To do so - to enable workers to live "freely" after
their working days are over - would require either (1) that bondholders
not be paid ("unthinkable") or (2) that property taxes be raised, forcing
even more homes into negative equity and leading to even more walkaways
and bank losses on their junk mortgages. Given the fact that the banks are
writing national economic policy these days, it doesn't look good for
people expecting a leisure society to materialize any time soon. The
problem for US officials is that Europe's sudden passion for slashing
public pensions and other social spending will shrink its economies,
slowing US export growth. US officials are urging Europe not to wage its
fiscal war against labor quite yet. Best to coordinate with the United
States after a modicum of recovery. Nonetheless, Saturday and Sunday will
see the six-month mark in a carefully orchestrated financial war against
the "real" economy.
The buildup began here in the United States. On February 18, President
Obama stacked his White House Deficit Commission (formally the National
Commission on Fiscal Responsibility and Reform) with the same brand of
neoliberal ideologues who comprised the notorious 1982 Greenspan
Commission on Social Security "reform".
The pro-financial, anti-labor and anti-government restructurings since
1980 have given the word "reform" a bad name. The commission is headed by
former Republican Wyoming Senator Alan Simpson (who explained derisively
that Social Security is for the "lesser people") and Clinton neoliberal
Erskine Bowles, who led the fight for the Balanced Budget Act of 1997.
Also on the committee are bluedog Democrat Max Baucus of Montana (the
pro-Wall Street Finance Committee chairman).
Obama's bipartisan advocacy for balanced budgets means in practice to stop
running budget deficits - the deficits that Keynes explained were
necessary to fuel economic recovery by providing liquidity and purchasing
power. A balanced budget in an economic downturn means shrinkage for the
private sector. Coming as the Western economies succumb to debt deflation,
the policy means shrinking markets for goods and services - all to support
banking claims on the "real" economy.
In April the exercise in managing public perceptions - to convince voters
that all this is a good thing - was escalated with the manufactured Greek
crisis. News media throughout the world breathlessly discovered that
Greece was not taxing the wealthy classes. They joined in a chorus to
demand that workers be taxed more, to make up for the tax shift off
wealth. This was Europe's version of the Obama Plan (that is, old-time
Europe's policy of planned shrinkage controverts the prime assumption of
political and economic textbooks: that voters act in their self-interest,
and that economies choose to grow, not to destroy themselves. Today,
European democracies - and even the Social Democratic, Socialist and
labour Parties - are running for office on a fiscal and financial policy
platform that opposes the interests of most voters, and even industry.
The explanation, of course, is that today's economic planning is not being
done by elected representatives. Planning authority has been relinquished
to the hands of "independent" central banks, which in turn act as the
lobbyists for commercial banks selling their product - debt. From the
central bank's vantage point, the "economic problem" is how to keep
commercial banks and other financial institutions solvent in a post-bubble
economy. How can they get paid for debts that are beyond the ability of
many people to pay, in an environment of rising defaults?
The answer is that creditors can get paid only at the economy's expense.
The remaining economic surplus must go to them, not to capital investment,
employment or social spending.
This is the problem with the financial view. It is short-term - and
predatory. Given a choice between operating the banks to promote the
economy, or running the economy to benefit the banks, bankers always will
choose the latter alternative. And so will the politicians they support.
The resulting Junk Economics is given what passes for academic legitimacy
by the Chicago School economic blinders placed on the World Bank, IMF and
other Washington Consensus institutions.
On June 3, the World Bank reiterated the New Austerity doctrine, as if it
were a new discovery: The way to prosperity is via austerity. "Rich
counties can help developing economies grow faster by rapidly cutting
government spending or raising taxes". The New Fiscal Conservatism aims to
corral all countries to scale back social spending in order to "stabilize"
economies by a balanced budget. This is to be achieved by impoverishing
labor, slashing wages, reducing social spending and rolling back the clock
to the good old class war as it flourished before the Progressive Era.
The rationale is the discredited "crowding out" theory: Budget deficits
mean more borrowing, which bids up interest rates. Lower interest rates
are supposed to help countries - or would, if borrowing was for productive
capital formation. But the way in which financial markets operate in
today's world is that lower interest rates simply make it cheaper and
easier for corporate raiders or speculators to capitalize a given flow of
earnings at a higher multiple, loading the economy down with even more
Alan Greenspan parroted the World Bank announcement almost word for word
in a June 18 Wall Street Journal op-ed. Running deficits is supposed to
increase interest rates. It looks like the stage is being set for a big
interest-rate jump - and corresponding stock and bond market crash as the
"sucker's rally" comes to an abrupt end in months to come.
The idea is to create an artificial financial crisis, to come in and
"save" it by imposing "Greek-style" cutbacks on European and North
American social security and pensions. For the United States, state and
local pensions in particular are to be cut back by "emergency" measures to
"free" government budgets.
The political problem inherent in the neoliberal worldview is that it
inverts the social philosophy that most voters hold. It is diametrically
opposed to the original liberalism of Adam Smith and his successors, whose
busts falsely decorate the entranceway to the neoliberal pantheon. The
world is being treated to a travesty of liberalism and free markets. The
classical idea of a free market was one free from predatory rentier
financial and property claims. Today, a "free market" Alan Greenspan and
Ayn Rand style is a market free for predators.
The World Bank/Greenspan argument that running a budget surplus will lower
interest rates and thus encourage capital formation and employment shows
the blind spot that has become a precondition for being approved for the
post of central banker these days. Central banks determine interest rates
by creating credit. That is what they were created to do. But the ECB's
"Maastricht" rules block central banks from doing this. European
governments are obliged to borrow from commercial banks.
This financial stranglehold threatens either to break up Europe or plunge
it into the same kind of poverty that the EU is imposing on the Baltics.
Latvia has been held out as the poster child for what is being recommended
for Greece and the other PIIGS: Slashing public spending on education and
health has reduced public-sector wages by thirty percent, and the
government expresses the hope for yet further cuts - spreading to the
private sector. Despite a plunge of over twenty percent in its GDP, its
government is running a budget surplus, in the hope of lowering wage
rates. Spending on hospitals, ambulance care and schooling has been
drastically cut back. Property prices have fallen by seventy percent - and
homeowners and their extended family of co-signers are liable for the
negative equity, plunging them into a life of debt peonage if they do not
take the hint and emigrate.
What is missing is an awareness that the cost of labor can be lowered by
progressive taxation and a tax shift back onto property - land and rentier
income. Instead, the cost of living is to be raised, by shifting the tax
burden further onto labor and off real estate and finance. The idea is for
the economic surplus to be pledged for debt service.
In England, Ambrose Evans-Pritchard has described a "euro mutiny" against
regressive fiscal policy. But it is more than that. Beyond merely
shrinking the economy, the neoliberal aim is to change the shape of the
trajectory along which Western civilization has been moving for the past
two centuries. It is to roll back Social Security and pensions for labor,
health care, education and other public spending, to dismantle the social
welfare state, the Progressive Era, and classical liberalism.
We are witnessing a policy long in the planning, being unleashed in a
full-court press. The rentier interests are fighting back - the vested
interests that a century of Progressive Era, New Deal and kindred reforms
sought to subordinate to the economy at large. And they are in control,
with their own representatives in power - ironically, as Social Democrats
and Labour party leaders, from President Obama here to President
Papandreou in Greece and President Jose Luis Rodriguez Zapatero in Spain.
Having bided their time for the past few years, strategists for the global
predatory class are now making their move to "free" economies from the
social philosophy long thought to have been built into the economic system
irreversibly: Social Security and old-age pensions so that labor will not
need to be paid higher wages to save for its retirement; public education
and health care to raise labor productivity; basic infrastructure spending
to lower the costs of doing business; anti-monopoly price regulation to
prevent prices from rising above the necessary costs of production; and
central banks to stabilize economies by monetizing government deficits, so
as to avoid forcing economies to rely on commercial bank credit. But as
matters have turned out, the banking system works by collateralizing
property and income are to pay the interest-bearing debts. Forfeitures are
the logical culmination of the Miracle of Compound Interest.
This is the Junk Economics that financial lobbyists are trying to sell to
voters: "Prosperity requires austerity". "An independent central bank is
the hallmark of democracy". "Governments are just like families: they have
to balance the budget". "It is all the result of aging populations, not
debt overload". These are the oxymorons to which the world will be treated
during the coming week in Toronto. They have become the vocabulary of
fiscal and financial class war.
A half-century of failed IMF austerity plans imposed on hapless Third
World debtors should have dispelled forever the idea that the way to
prosperity is via austerity. The ground has been paved for this attitude
by a generation of purging the academic curriculum of knowledge that there
ever was an alternative economic philosophy to that sponsored by the
rentier Counter-Enlightenment. Classical value and price theory reflected
John Locke's labor theory of property: A person's wealth should be what he
or she creates with their own labor and enterprise, not by insider dealing
or special privilege.
Instead, wealth has been made in recent decades by debt leveraging -
running into debt to buy real estate, stocks and bonds being loaded down
with interest and amortization charges, turning land rent and business
earnings into interest and capital gains for bankers and other financial
institutions - and for wealth at the top of the economic pyramid. It was a
mad dream, and now the world is waking up, although probably not the
visitors to Toronto this weekend.
The problem is that there is not enough economic surplus available to pay
the financial sector on its bad loans while also paying pensions and
social security. Something has to give. The commission is to provide a
cover story for a revived Rubinomics, this time aimed not at the former
Soviet Union but here at home. Its aim is to scale back Social Security
while reviving George Bush's aborted privatization plan to send FICA
paycheck withholding into the stock market - that is, into the hands of
money managers to stick into an array of junk financial packages designed
to skim off labor's savings.
So Mr Obama is hypocritical in warning Europe not to go too far too fast
to shrink its economy and squeeze out a rising army of the unemployed. His
idea is to do the same thing. The strategy is to panic voters about the
federal debt - panic them enough to oppose spending on the social programs
designed to help them. The fiscal crisis is being blamed on demographic
mathematics of an aging population - not on the exponentially soaring debt
overhead, junk loans and massive financial fraud. What really is causing
the financial and fiscal squeeze is the fact that that government funding
is now needed to compensate the financial sector for what promises to be
year after year of losses as loans go bad in economies that are all loaned
up and sinking into negative equity.
Somebody must take a loss on the bankers' bad loans - and they want the
economy to take it, to "save the financial system". From their vantage
point, economies should be managed to preserve bank liquidity, rather than
the financial system run to serve the economy. Corporate cash flow is to
be used to pay creditors, not employ more labor and make long-term capital
investment. Government social spending (on everything apart from bank
bailouts and financial subsidies) and disposable personal income are to be
cut back rather than writing down the debt overhead.
The economy is to be sacrificed to subsidize the fantasy that debts can be
paid, if only banks can be "made whole" to begin lending again - that is,
to load the economy down with even more debt, causing yet more intrusive
debt deflation. That is what happens when politicians let the financial
sector run the show: Their natural preference is to turn the economy into
a grab bag. And they usually come out ahead. That's what the words
"foreclosure," "forfeiture" and "liquidate" mean - along with "sound
money," "business confidence" and the consequent "debt deflation" and
This is not the familiar old 19th-century class war of industrial
employers against labor, although that is part of what is happening. It is
a war of the financial sector against the "real" economy: industry as well
as labor. The economy is being sacrificed to an impossible dream. For the
past fifty years the Western economies have indulged the fantasy of paying
retirees out of purely financial gains (M-M' as Marxists would put it),
not out of an expanding economy (M-C-M', employing labor to produce more
The myth is that banks make productive loans to increase capital formation
and hiring. The reality is that finance takes the form of debt - and
gambling. And pensions cannot be paid - at least, not paid out of
financial gains. These gains are made from the economy at large. They are
extractive, not productive, shrinking the base of the economic pyramid.
So something has to give. The question is, what form will the "give" take?
And who will do the giving - and who will be the recipients?
The Greek government ran into trouble because it was unwilling to tax the
rich. So labor must make up the fiscal gap, by permitting its socialist
government to cut back pensions, health care, education and other social
spending - all to bail out the financial sector from an exponential growth
that is impossible to realize in practice. Yet instead of blaming the
problem on the exponential growth in bank claims that cannot be paid, bank
lobbyists - and the G-20 politicians dependent on their campaign funding -
are promoting the myth that the problem is demographic: an aging
population expecting Social Security and employer pensions. Instead of
paying these, governments are being told to use their taxing and
credit-creating power to bail out the financial sector's claims for
The pretense for cutting back government budget in the face of a
post-bubble downturn is that this will rebuild "confidence" - as if fiscal
self-destruction can instill confidence rather than prompting investors to
flee the euro. The logic is that of the familiar old class war, rolling
back the clock to the hard-line tax philosophy of a bygone era - rolling
back Social Security and public pensions, rolling back public spending on
education and other basic needs, and above all, increasing unemployment to
drive down wage levels.
It is a self-destructive logic. Economic downturns reduce tax revenues,
making budget deficits even worse. Latvia's experience shows that the
response to economic shrinkage is emigration of skilled labor and capital
The pressing financial and fiscal problem is that governments need huge
sums to bail out the banks from their bad loans. But they cannot borrow
more, because their taxing power has reached the political limit - unless,
of course, governments were to apply the classical liberal policy of
taxing finance and property as urged by the Physiocrats, Adam Smith, John
Stuart Mill, Ferdinand Lassalle et al. So the bad-debt loss must be passed
onto labor and industry.
The cover story is that government bailouts will permit the banks to start
lending again, to reflate the Bubble Economy's Ponzi-borrowing. But there
is already too much negative equity and there is no leeway left to restart
the bubble. Economies are all "loaned up". Real estate rents, corporate
cash flow and public taxing power cannot support further borrowing - no
matter how much wealth the government gives to banks. Asset prices have
plunged into negative equity territory. Debt deflation is shrinking
markets, corporate profits and cash flow. The Miracle of Compound Interest
dynamic has culminated in defaults, reflecting the inability of debtors to
sustain the exponential rise in carrying charges that "financial solvency"
The ultimate political question
If the financial sector can be rescued only by cutting back social
spending on Social Security, health care and education, bolstered by more
privatization sell-offs, is it worth the price? To sacrifice the economy
in this way would violate most peoples' social values of equity and
fairness rooted deep in Enlightenment philosophy.
That is the political problem: How can bankers persuade voters to approve
this under a democratic system? It is necessary to orchestrate and manage
their perceptions. Their poverty must be portrayed as desirable - as a
step toward future prosperity.
This is why I say that Europe is dying. If its trajectory is not changed,
the EU must succumb to a financial coup d'etat rolling back the past three
centuries of Enlightenment social philosophy. The question is whether a
break-up is now the only way to recover its social democratic ideals from
the banks that have taken over its central planning organs.