|Why Paul Krugman Waves the Flag for Uncle Sam
by Michael Hudson
HERE'S THE QUANDARY THAT the US economy is in: The Fed's quantitative
easing policy? creating more liquidity so that banks can lend more - aims
at helping the economy "borrow its way out of debt". But banks are not
lending more, for the simple reason that a third of US real estate already
is in negative equity, while small and medium-sized businesses (which have
created most of the new jobs in America for the past few decades) have
seen their preferred collateral (real estate and sales orders) shrink. How
can banks be expected to lend more to re-inflate the economy's asset
prices while wages and consumer prices continue to drift down? The "real"
economy as a whole therefore must shrink.
What has made the argument over Fed policy so important over the past week
is a series of exchanges between Republicans and Democrats. The
deteriorating situation prompted a group of Republican economists and
political strategists to publish an open letter to Federal Reserve
Chairman Ben Bernanke criticizing the Fed's policy of Quantitative Easing
(QE2), flooding the economy with liquidity spilling over into foreign
exchange markets to push the dollar's exchange rate down. True enough, as
far as this criticism goes. But it only scratches the surface.
Enter Paul Krugman, one of the most progressive defenders of Democratic
Party policy. His New York Times op-eds usually rebut Republican advocacy
for Wall Street and corporate interests. But he also indulges in China
bashing. To "blame the foreigner" rather than the system is normally a
right-wing response, yet Krugman blames China simply for trying to save
itself from being victimized by the Wall Street policies he normally
criticizes when labor is the prey. By blaming China, he not only lets the
Federal Reserve Board and its Wall Street constituency off the hook, he
blames virtually the entire world that confronted Obama's financial
nationalism with a united front in Seoul two weeks ago when he and his
entourage received an almost unanimous slap in the face at the Group of
Sadly, Krugman's "Axis of Depression" column on Friday, November 19,
showed the extent to which his preferred solutions do not go beyond merely
marginalist tinkering. His op-ed endorsed the Fed's attempt at
quantitative easing to re-inflate the real estate bubble by flooding the
markets with enough credit to lower interest rates. He credits the Fed
with seeking to "create jobs", not mainly to bail out banks that hold
mortgages on properties in negative equity.
The reality is that re-inflating real estate prices will not make it
easier for wage earners and homebuyers to make ends meet. Lowering
interest rates will re-inflate real estate prices ("wealth creation"
Alan-Greenspan style), raising the degree to which new homebuyers must go
into debt to obtain housing. And the more debt service that is paid, the
less is available to spend on goods and services (the "real" economy).
Employment will shrink in a financial spiral of economic austerity.
Unfortunately, most economists are brainwashed with the trivializing
formula MV=PT. The idea is that more money (M) increases "prices" (P) -
presumably consumer prices and wages. (One can ignore velocity, "V", which
is merely a tautological residual.) "T" is "transactions", for GDP,
sometimes called "O" for Output.
Some 99.9 per cent of money and credit is not spent on consumer goods (the
"T" in MV = PT). Every day more than an entire year's GDP passes through
the New York Clearing House and the Chicago Mercantile Exchange for bank
loans, stocks and bonds, packaged mortgages, derivatives and other
financial assets and bets. So the effect of the Fed's Quantitative Easing
(monetary inflation) is to inflate asset prices, not consumer prices and
other commodity prices.
This is the key dynamic of today's finance capitalism. It loads down
economies with debt - and when debt service exceeds the surplus out of
which to pay it, the central bank tries to "inflate its way out of debt"
by creating enough new credit ("money") to make real estate, stocks and
bonds worth more - enough more for debtors to borrow the interest due.
This is the deus ex machina, the external influx of credit enabling
financialized economies to operate as Ponzi schemes. The dynamic is
encouraged by taxing speculative ("capital") gains at a lower rate than
wages and profits. So why should investors finance tangible capital
investment when they can ride the wave of asset-price inflation. The
Bubble Economy turns into speculative "wealth creation".
Can it work? How long will gullible investors bet on a pyramid scheme
growing at an impossibly exponential rate, enjoying fictitious "wealth
creation" as bankers load the economy down with debt? How long will people
think that the economy is really growing when banks lend to an economy
overseen by regulatory agencies staffed by ideological deregulators?
The bankers' ideal is for the entire surplus over and above bare
subsistence to be paid in the form of interest and fees - all disposable
personal income, corporate cash flow and real estate rent. So when the
Fed's QE lowers mortgage interest rates, will this enable homeowners to
pay less - or will it simply increase the capitalization rate of existing
The Fed's cover story is that QE benefits homebuyers by reducing the debt
they must take on. But if this were true, their gain would be the banks'
loss - and the bankers are the Fed's main constituency. To the Federal
Reserve, the economic "problem" is that falling (that is, more affordable)
housing prices are killing the balance sheets of banks. So the Fed's real
goal is to re-inflate the real estate bubble (while spurring a stock
market bubble as well, if it can).
A Wall Street Journal op-ed by Andy Kessler (also published on Friday,
November 19, the date of Krugman's op-ed in The New York Times) pointed
this out - but also recognized that the Fed would create a public
relations disaster if it came right out and explained that its motivation
in QE2 was to reverse the fall in property prices. "Bernanke would create
a panic if he stated publicly that, if not for his magic dollar dust, real
estate would fall off a cliff", and admitted that bank balance sheets
still suffer from "toxic real estate loans and derivatives". But the
degree to which reported bank solvency is largely fictitious is reflected
in the fact that the stock market value for the Bank of America (which
brought Countrywide Finance) is only half its reported book value, while
that of Citibank is off by twenty per cent.
Foreclosure is of course bad for homeowners, but it is even worse for
banks, because of the financial pyramid of credit erected on the past
decade's worth of junk mortgages. The problem with Krugman's analysis is
his assumption that QE - intended to re-inflate the real estate bubble -
is good for employment and indeed even for a renewal of US
competitiveness, not its antithesis. By focusing on trade and labor, he
implies that the dollar is weakening only because of the trade deficit,
not because of military spending and capital flight. And he assumes that
re-inflating the real estate bubble - the Fed's explicit aim - will make
US exports more competitive rather than less so! Most seriously, he
asserts in his November 19 column, "the core reason for the attack on the
Fed is self-interest, pure and simple. China and German want America to
This is not what I have been told in China and Germany. They simply want
to avoid having instability disrupt their trade and domestic production,
and to avoid having to take a loss on their international reserves held
(mainly from inertia stemming from World Wars I and II when the United
States increased its share of the world's gold to eighty per cent by
1950). The US Treasury would like US banks and speculators to make an easy
$500 billion at the expense of China's central bank on slick speculative
currency trading. The Fed would like to see the US economy revive by
looting other economies.
It's not going to happen. The plunging-dollar standard of international
finance is being wound down as fast as other countries are able to replace
the dollar with currency swaps among themselves, led by the BRIC countries
(Brazil, Russia, India and China). South Africa has just joined these
countries as a fifth member, and oil exporters from Nigeria to Venezuela
and Iran are associating themselves in the attempt to make the
international monetary system less unfair and less exploitative. Krugman's
fellow Nobel Prize winner, Joseph Stiglitz has provided (seemingly
ironically, also in a Wall Street Journal op-ed): "That money is supposed
to reignite the American economy but instead goes around the world looking
for economies that actually seem to be functioning well and wreaking havoc
The Fed and Congress have told China to revalue its currency, the
renminbi, upward by twenty per cent. This would oblige the Chinese
government and its central bank to absorb a loss of half a trillion
dollars - over $500 billion - on the $2.6 trillion of foreign reserves it
has built up. These reserves are not merely from exports, much less
exports to the United States. They are capital flight by US money
managers, Wall Street arbitragers, international speculators and others
seeking to buy up Chinese assets. And they are the result of US military
spending in its bases in Asia and elsewhere - dollars that recipient
countries turn around and spend in China.
Chinese authorities have tried to make it clear that what they object to
is the US policy of creating "electronic keyboard credit" at one quarter
of a percent (0.25 per cent) to buy up higher yielding assets abroad (and
nearly every foreign asset is higher yielding). The Group of Twenty in
Seoul Korea last week accused the United States of competitive currency
depreciation and financial aggression, and countries stepped up attempts
to shun the dollar and indeed, to avoid running trade and payments
surpluses as such.
The bottom line is that there is no way that the United States can defend
depreciation of the dollar on terms that oblige other countries to take a
loss on their holdings. Investors throughout the world have lost faith in
the dollar and other paper currencies, and are moving into gold or simply
closing off their economies. Over the past year - ever since the BRIC
meetings in Yekaterinburg, Russia, in summer 2009 - their response has
been to avoid using the dollar, to protect themselves from aggressive US
capital flight seeking to raid their central banks, buy out their
companies, raw materials and assets with "paper credit" and indeed to step
up military spending.
Instead of supporting this attempt - a drive that has the positive
consequence for world peace that it will limit US military adventurism
(much as the Vietnam War finally forced the dollar off gold in 1971),
Krugman is using the crisis to attack China - as if its success is what is
harming US labor, not US post-industrial pro-financial policies that have
inflated the real estate bubble, privatized health care without a public
option - and without even a bulk discount for US Government drug purchases
- and the failure to write down mortgages and other bank debts to the
ability to pay.
Today's China-bashing is much like the earlier attacks on Japan and other
Asian countries in the late 1980s, demonizing successful economies for
avoiding the predatory practices that have corroded American industry,
"financializing" and post-industrializing the economy. The US debt
pyramiding that has occurred since 1980 has turned into a class war that
has little economic justification. So blaming foreigners - for getting
rich in the very same way that the United States has done ever since the
North won the Civil War in 1865 - simply offers political cover for a
status quo that is not working.
The two US parties and their spokesmen find it easier to demonize policies
that go beyond the merely marginal than to set about solving structural
problems. So political discussion ends up by highlighting fairly
insignificant policy differences. One would hardly realize that the
problem facing US industrial employment is that wage earners must earn
enough to pay for the most expensive housing in the world (the FDIC is
trying to limit mortgages to absorb just 32 per cent of the borrower's
budget), the most expensive medical care and Social Security in the world
(12.4 per cent FICA withholding), high personal debt levels owed to banks
and rapacious credit-card companies (about fifteen per cent) and a tax
shift off property and the higher wealth brackets onto labor income and
consumer goods (another fifteen per cent or so). The aim of bankers is to
calculate just how much their customers can pay, defined as everything
they make over and above basic subsistence costs and "non-discretionary"
spending to the FIRE sector.
This is post-industrial suicide - and it is the road to debt peonage for
American wage earners and consumers. China has created an economy that has
managed - so far - to avoid financializing its firms. The government owns
over half the equity in its commercial banks. According to its Ministry of
Finance, assets of all state enterprises in 2008 totaled about $6 trillion
(equal to 133 per cent of annual economic output.) The effect is that when
loans are made to domestic enterprises - especially to [those] partially
or wholly owned by the government - the interest and financial returns
accrues to the public sector, making it unnecessary to tax labor.
China understandably is trying to defend this system. Yet the Obama
administration (echoed by Republican free marketers) has criticized it,
especially for its public subsidy of solar energy investment to slow
domestic pollution and global warming. Wednesday's Wall Street Journal
provided an almost comically hypocritical attack earlier last week (Jason
Dean, Andrew Browne and Shai Oster, "China's 'State Capitalism' Sparks a
Global Backlash") decrying China's accelerated investment in solar power
to free its economy (and its air quality) from oil imports and carbon
emissions. "It leverages state control of the financial system to channel
low-cost capital to domestic industries - and to resource-rich foreign
nations whose oil and minerals China needs to maintain rapid growth".
This policy prompted Charlene Barshefsky, US trade representative under
President Bill Clinton (who helped negotiate China's 2001 entry into the
World Trade Organization) to complain that "powerful state-led economies
like China and Russia ... decide that 'entire new industries should be
created by the government' ... it tilts the playing field against the
private sector". This is just what Japan did to promote its
industrialization - by providing government credit intended to promote
tangible capital investment, not extract financial rake-offs. "Vast swaths
of industry still controlled by state companies and tightly restricted for
foreigners", complain the Wall Street Journal authors. "The government
owns almost all major banks in China, its three major oil companies, its
three telecom carriers and its major media firms".
We are dealing with two quite different ideas of what the proper role of a
financial system should be. Commercial banks in the West have created most
credit for speculation and asset-price inflation over the last thirty
years, not to fund capital formation and industry. The guiding idea of a
public-sector bank is to promote long-term investment to raise
productivity, output and employment. This is what has enabled China to
succeed so rapidly while Western economies have let themselves be
financialized. The Baltics, Iceland and now Ireland are examples of the
disaster that financial neoliberals cause when given a free hand.
The moral is that China's bank success - and its attempt to avert US
currency raiding and arbitrage speculation seeking to loot its foreign
reserves - should be emulated, not accused of being economic warfare. This
emulation is what the BRIC+ countries have announced as their goal. The
Obama administration and European politicians certainly are making an
obvious point in urging China to focus more on its own domestic market and
accelerate the rise in its living standards. It is clear that markets in
the United States and Europe are shrinking as debt deflation sets in.
China is not as economically self-sufficient in natural resources and
water as the United States. This means that a sustained rise in its living
standards will require spending much of the international savings it has
built up. But at least it is on the right path. Can the same be said of
America? Does it help to denounce China, or should we rather ask why its
productivity, capital investment and living standards are rising while
ours are declining?
Asking this question suggests the answer: China's financial system is
designed to promote a growing surplus, not siphon it off. A byproduct is
to increase real estate and stock market prices - but this is a reflection
of capital investment and progress, not a diversion of investment to fuel
financial asset stripping as has occurred in the United States with
increasingly arrogant greed over the past thirty years.
What Krugman and other economists advocating for wage earners and the
economy at large should be concerned with is the danger of the Fed
undertaking yet another back-door bailout its Wall Street constituency.
Kessler suggests that the Fed should do just this - to "move the toxic
debt onto the balance sheets of the FDIC and the Fed, and re-float the
banks with fresh capital to open on Monday morning".
You can't blame China for this!
Michael Hudson is a former Wall Street economist. A Distinguished Research
Professor at University of Missouri, Kansas City (UMKC), he is the author
of many books, including Super Imperialism: The Economic Strategy of
American Empire (new edition, Pluto Press, 2002) and Trade, Development
and Foreign Debt: A History of Theories of Polarization vs Convergence in
the World Economy (2009). He can be reached via his website,
> _why_ do you think that it's "tripe"?
Let me count the ways. First of all, the $2.6T stockpile of dollars is
in large measure due to persistent trade imbalance NOT speculative
capital flight. Speculative inflows exist of course and maybe even
substantial but it is beyond ridiculous to ignore the elephant in the
room i.e. export dollars. Secondly, we have to really stupid to fall
for the PRC's cover story that capital losses are the reason why they
don't like Bernanke's money printing; there is another stronger motive
for their complaining which is that it makes maintaining their
preferred currency exchange rates more difficult. Thirdly, what has US
military spending have to do with the PRC's dollar hoarding (except in
some convoluted indirect sense in which everything that happens in the
universe is part of One Holistic Reality)??
Let's face, this is two ugly imperialists facing off against each
other. What sense does it make to take sides in such a fight?