RWER issue 57: Michael Hudson
How economic theory came to ignore the role of debt
Starting from David Ricardo in 1817, the historian of economic thought searches in vain through the theorizing of financial-sector spokesmen for an acknowledgement of how debt charges (1) add a non-production cost to prices, (2) deflate markets of purchasing power that otherwise would be spent on goods and services, (3) discourage capital investment and employment to supply these markets, and hence (4) put downward pressure on wages.
What needs to be explained is why government, academia, industry and labor have not taken the lead in analyzing these problems. Why have the corrosive dynamics of debt been all but ignored?
I suppose one would not expect the tobacco industry to promote studies of the unhealthy consequences of smoking, any more than the oil and automobile industries would encourage research into environmental pollution or the linkage between carbon dioxide emissions and global warming. So it should come as little surprise that the adverse effects of debt are sidestepped by advocates of the idea that financial institutions rather than government planners should manage society’s development. Claiming that good public planning and effective regulation of markets is impossible, monetarists have been silent with regard to how financial interests shape the economy to favor debt proliferation.
The problem is that governments throughout the world leave monetary policy to the Central Bank and Treasury, whose administrators are drawn from the ranks of bankers and money managers. Backed by the IMF with its doctrinaireChicagoSchooladvocacy of financial austerity, these planners oppose full-employment policies and rising living standards as being inflationary. The fear is that rising wages will increase prices, reducing the volume of labor and output that a given flow of debt service is able to command.
Inasmuch as monetary and credit policy is made by the central bank rather than by the Dept. of Labor, governments chose to squeeze out more debt service rather than to promote employment and direct investment. The public domain is sold off to pay bondholders, even as governments cut taxes that cause budget deficits financed by running up yet more debt. Most of this new debt is bought by the financial sector (including global institutions) with money from the tax cuts they receive from governments ever more beholden to them. As finance, real estate and other interest-paying sectors are un-taxed, the fiscal burden is shifted onto labor.
The more economically powerful theFIREsector (Finance, Insurance and Real Estate) becomes, the more it is able to translate this power into political influence. The most direct way has been for its members and industry lobbies to become major campaign contributors, especially in theUnited States, which dominates the IMF and World Bank to set the rules of globalization and debt proliferation in today’s world. Influence over the government bureaucracies provides a mantel of prestige in the world’s leading business schools, which are endowed largely byFIRE-sector institutions, as are the most influential policy think tanks. This academic lobbying steers students, corporate managers and policy makers to see the world from a financial vantage point.
Finance and banking courses are taught from the perspective of how to obtain interest and asset-price gains through credit creation or by using other peoples’ money, not how an economy may best steer savings and credit to achieve the best long-term development. Existing rules and practices are taken for granted as “givens” rather than asking whether economies benefit or suffer as a whole from a rising proportion of income being paid to carry the debt overhead (including mortgage debt for housing being bid up by the supply of such credit). It is not debated, for instance, whether it really is desirable to finance Social Security by holding back wages as forced savings, as opposed to the government monetizing its social-spending deficits by free credit creation.
The finance and real estate sectors have taken the lead in funding policy institutes to advocate tax laws and other public policies that benefit themselves. After an introductory rhetorical flourish about how these policies are in the public interest, most such policy studies turn to the theme of how to channel the economy’s resources into the hands of their own constituencies.
One would think that the perspective from which debt and credit creation are viewed would be determined not merely by the topic itself but whether one is a creditor or a debtor, an investor, government bureaucrat or economic planner writing from the vantage point of labor or industry. But despite the variety of interest groups affected by debt and financial structures, one point of view has emerged almost uniquely, as if it were objective technocratic expertise rather than the financial sector’s own self-interested spin. Increasingly, the discussion of finance and debt has been limited to monetarists with an anti-government ax to grind and vested interests to defend and indeed, promote with regard to financial deregulation.
This monetarist perspective has become more pronounced as industrial firms have been turned into essentially financial entities since the 1980s. Their objective is less and less to produce goods and services, except as a way to generate revenue that can be pledged as interest to obtain more credit from bankers and bond investors. These borrowings can be used to take over companies (“mergers and acquisitions”), or to defend against such raids by loading themselves down with debt (taking “poison pills”). Other firms indulge in “wealth creation” simply by buying back their own shares on the stock exchange rather than undertaking new direct investment, research or development. (IBMhas spent about $10 billion annually in recent years to support its stock price in this way.) As these kinds of financial maneuvering take precedence over industrial engineering, the idea of “wealth creation” has come to refer to raising the price of stocks and bonds that represent claims on wealth (“indirect investment”) rather than investment in capital spending, research and development to increase production.
Labor for its part no longer voices an independent perspective on such issues. Early reformers shared the impression that money and finance simply mirror economic activity rather than acting as an independent and autonomous force. Even Marx believed that the financial system was evolving in a way that reflected the needs of industrial capital formation.
Today’s popular press writes as if production and business conditions take the lead, not finance. It is as if stock and bond prices, and interest rates, reflect the economy rather than influencing it. There is no hint that financial interests may intrude into the “real” economy in ways that are systematically antithetical to nationwide prosperity. Yet it is well known that central bank officials claim that full employment and new investment may be inflationary and hence bad for the stock and bond markets. This policy is why governments raise interest rates to dampen the rise in employment and wages. This holds back the advance of living standards and markets for consumer goods, reducing new investment and putting downward pressure on wages and commodity prices. As tax revenue falls, government debt increases. Businesses and consumers also are driven more deeply into debt.
The antagonism between finance and labor is globalized as workers in debtor countries are paid in currencies whose exchange rate is chronically depressed. Debt service paid to global creditors and capital flight lead more local currency to be converted into creditor-nation currency. The terms of trade shift against debtor countries, throwing their labor into competition with that in the creditor nations.
If today’s economy were the first in history to be distorted by such strains, economists would have some excuse for not being prepared to analyze how the debt burden increases the cost of doing business and diverts income to pay interest to creditors. What is remarkable is how much more clearly the dynamics of debt were recognized some centuries ago, before financial special-interest lobbying gained momentum. Already in Adam Smith’s day it had become a common perception that public debts had to be funded by tax levies that increased labor’s living costs, impairing the economy’s competitive position by raising the price of doing business. The logical inference was that private-sector debt had a similar effect.
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