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Michael Hudson and Chris Hedges: The Real World Cost of Turning Classical Economics Upside Down
Posted on March 23, 2016 by Yves Smith

Yves here. You are getting a big dose of Michael Hudson this week because he had interviews that were made weeks apart released in a tight timeframe. Several readers have already flagged this talk, and Hudson is in top form, and also covers a wide range of issues in a comparatively short time frame.

Today’s episode is from a teleSUR interview with Chris Hedges that focuses on one of Hudson’s favorite themes: the way that central messages of classical economics have been airbrushed out of the current economic orthodoxy, or worse, turned on their head. Classical economics was concerned with eradicating the vestiges of feudalism, which led to concerns about deadweight costs like rent extraction as well as distortions caused by monopolies and oligopolies. While it does not come up in this talk, another concern of classical economics was the productive use of lending. Classical economists favored usury ceilings because lenders otherwise would fund speculation (in those days, gambling by the rich) as opposed to funding commerce.

CHRIS HEDGES: Hi, I’m Chris Hedges. Welcome to Days of Revolt. Today in a two-part series we’re going to be discussing a great Ponzi scheme that not only defines not only the U.S. but the global economy, how we got there, in the first segment, and secondly, where we’re going. And with me to discuss this issue is the economist Michael Hudson, author of Killing the Host: How Financial Parasites and Debt Destroy the Global Economy, a professor of economics who worked for many years on Wall Street, where you don’t succeed if you don’t grasp Marx’s dictum that capitalism is about exploitation. And he is also, I should mention, the godson of Leon Trotsky. Welcome Michael.

MICHAEL HUDSON: Thank you. Good to be here.

HEDGES: I want to open this discussion by reading a passage from your book, which I admire very much, which I think gets to the core of what you discuss. You write, “Adam Smith long ago remarked that profits often are highest in nations going fastest to ruin.” There are many ways to create economic suicide on a national level. The major way through history has been through indebting the economy. Debt always expands to reach a point where it cannot be paid by a large swathe of the economy. This is the point where austerity is imposed and ownership of wealth polarizes between the one percent and the ninety-nine percent. Today is not the first time this has occurred in history. But it is the first time that running into debt has occurred deliberately. Applauded. As if most debters can get rich by borrowing, not reduced to a condition of debt peonage.

So let’s start with classical economics, who certainly understood this. They were reacting of course to feudalism. And what happened to the study of economics so that it became gamed by ideologues?

HUDSON: Well, the essence of classical economics is to reform industrial capitalism, to streamline it, and to free the European economies from the legacy of feudalism. And the legacy of feudalism, where the landlords that were extracting land-rent, and living as a class that took income without producing anything. And the banks, which were not funding industry; the leading industrialists from James Watt, with his steam engine, to the railroads–.

HEDGES: From your book you make the point that banks almost never funded industry.

HUDSON: That’s the point. That they never had. And by the time you got to Marx, later in the 19th century, you had a whole discussion, largely in Germany, over “how do we make banks do something they did not do under feudalism?” Right now we’re having the economic surplus being drained by the landlords and drained by the bond holders.
Adam Smith was very much against colonialism because that lead to wars, because that led to public debt. And he said the solution to prevent this financial class of bond holders burdening down the economy by imposing more and more taxes on consumer goods every time they went to war was to finance wars on a pay-as-you-go basis. Instead of borrowing you’d tax the people then he thought that if everybody felt the burden of war, in the form of paying taxes, then they’d be against it. Well, it took all of the 19th century to fight for democracy and to extend the vote so that instead of the landlords controlling the parliament and the law making and the tax system through the House of Lords, you’d extend the vote to labor, to women, to everybody on the theory that society as a whole would vote in its self-interest, and that it would vote for the 99% and not for the 1%.

And so by the time Marx wrote in the 1870s he could already see what was happening in Germany, that the German banks were trying to make money, in conjunction with the government, by lending to heavy industry, largely to the military-industrial complex.

HEDGES: This was Bismark’s kind of social, I don’t know what we’d call it, it was a form of capitalist socialism.

HUDSON: They called it State Capitalism–.

HEDGES: State Capitalism.

HUDSON: And there was a long discussion by Engels, saying, wait a minute. State Socialism whereas State Capitalism isn’t what we mean by socialism. And there are two kinds of state-oriented–.

HEDGES: I’m going to interject I mean there was a kind of brilliance behind Bismarck’s policy because–.

HUDSON: –Sure.

HEDGES: –he created pension funds, he provided health benefits, and he directed banking towards industry; towards the industrialization of Germany, which as you point out, was very different in Britain and the United States.

HUDSON: Well, the German banking was so successful that by the time World War I broke out, there were discussions in the English journals saying, we’re worried that Germany and the Axis powers are going to win because their banks are more suited to fund industry, and without industry you can’t have really a military. Whereas the British banks only lend for foreign trade, they’d lend for speculation, and the stock market is a hit-and-run operation; they want a quick in-and-out to make the profits, whereas the German banks don’t insist that their clients pay as much dividends. The German banks own stocks as well as bonds, and there’s much more of a partnership.

And that’s what most of the 19th century imagined was going to happen. That the world was on the way to socializing banking. Towards moving capitalism beyond the feudal level and getting rid of the landlord class, getting rid of the rent, getting rid of interest and really it was going to be labor and capital, profits and wages, with the profits being reinvested in more capital and you’d have an expansion of technology. And around the early twentieth century, most futurists imagined that we’d be living in a leisure economy by now.

HEDGES: Including Karl Marx.

HUDSON: That’s right, yeah. Ten-hour work week. And to Marx, socialism was just the reformed state of capitalism at the time.

HEDGES: Isn’t what happened in large part because of the defeat of Germany in World War I? But also, because we took the understanding of economists like Adam Smith and maybe Keynes, and, I don’t know who you would blame for this, whether it’s [Ricard] or others, and we created a fictitious economic form or economic theory that erased rentier or rent-derived interest-derived capitalism and countered it as a productive force within the economy. Perhaps you can address that.

HUDSON: Well, here’s what happened. Marx sort of traumatized classical economics by taking the concepts of Adam Smith and John Stewart Mill and the others, and pushing them to the logical conclusion. He said that the progressive capitalism, people called Ricardian socialists like John Stewart Mill, said okay, we want to tax away the land or nationalize it, we want to have the government take over the heavy industry and build infrastructure to provide low-cost basic services. This was traumatizing the landlord class and the one percent. And they fought back.

Now, none of the classical economists could even imagine, how on earth can the feudal interests, these great vested interests that had all this money, actually fight back and succeed. They thought the future was going to belong to capital and labor. And around the late 19th century, certainly in America, you had people like John Bates Clark come out with a completely different theory. The whole classical economics, what made Adam Smith and the physiocrats and John Stewart Mill.

HEDGES: Physiocrats are, you’ve tried to explain, are the French, these enlightened French economists.

HUDSON: The common denominator among all of the classical economists was the distinction between earned income and unearned income. And the unearned income was rent and interest. The earned income were wages and profits. Well, John Bates Clark came and said, there’s no such thing as unearned income. The landlord actually earns the money by taking all this effort to provide a house and land to renters, and the banks that provide credit. Their interest–every kind of income is, everybody earns their income. So everybody who accumulates wealth, by definition, according to his formulas, get rich by adding to what is now called gross domestic product.

HEDGES: And I think one of the points you make in your book which I liked was that in almost all cases, those who had the capacity to make money parasitically off interest and rent had either, if you go back to the origins, looted and seized the land by force, or inherited it.

HUDSON: That’s correct. In other words, the unearned income. Well, the result of this sort of anti-classical revolution that you had just before World War I was that today almost all of the economic growth in the last decade has gone to the 1%. It’s gone to Wall Street, real estate–.

HEDGES: But you blame this on what you call junk economics.

HUDSON: Well, the junk economics is the anti-classical reaction.

HEDGES: And explain a little bit how, in essence, that’s a fictitious form of measuring the economy.

HUDSON: Well, suppose you have a crook, and you’re taking, you’re going to the bank. I went to a, a block away we had a Chase Manhattan bank, and I used to bank there. I took out money from the bank, and as I was going out, two pickpocket–one pushed me over and the other grabbed the money, and ran out. Just–I was ten feet from the teller. The guard stood there, and saw it, and actually asked for the money back. And said, look, I was robbed in your bank, right in front. And they said, well, you know, we don’t arm our guards because if they shot one of the people, the thief could sue us and we don’t want to do that. We’ll just give you money back.

Well, imagine if you count all of this crime, all the money that’s taken, as an addition to GDP. Because now the crook has provided the service of not pushing me down or not stabbing me. Or suppose somebody’s held up at an ATM machine, your money or your life. Okay, here’s the money. The crook has given you the choice of your life. In a way that’s how the gross national product accounts are put up. You have Wall Street extracting money from the economy. You have landlords extracting–.

HEDGES: And there–let’s go back. They’re extracting money from the economy by debt peonage. By raising–.

HUDSON: By not playing a productive role, basically.

HEDGES: Right. So it’s credit card interest, mortgage interest, car loans, student loans, that’s how they make their funds.

HUDSON: That’s right. So they don’t, money is not a factor of production. But in order to have access to credit, in order to get the money, in order to get an education, you have to pay the banks. And at New York University here, for instance, they have Citibank, I think Citibank people were on the board of directors at NYU. You get the students, when they come here, to start at the local bank. And once you are in a bank and have monthly funds taken out of your account for electric, utilities, or whatever, it’s very hard to change.

So basically you have what the classical economists called the rentier class. The class that lives on economic rents. Landlords, monopolists charging more, and the banks. So that if you have a pharmaceutical company such that raises the rate of drug from $12 a shot to $200, that’s all of a sudden, their profits go up. Their increased price for the drug is created, is counted in the national income accounts, as if the economy is producing more. So all of this presumed economic growth that has all been taken by the 1% in the last ten years, and people say the economy is growing. But the economy isn’t growing–.

HEDGES: Because it’s not reinvested.

HUDSON: That’s right. It’s not–it’s not production, it’s not consumption. The wealth of the 1% is obtained by essentially lending money to the 99% and then charging interest on it, and recycling this interest at an exponentially growing rate.

HEDGES: And why is it important, as I think you point out in your book, that economic theory counts this rentier income as productive income? Explain why that’s important.

HUDSON: If you’re a rentier, then you want to say that, hey, I earned my income by–.

HEDGES: We’re talking about Goldman Sachs, by the way.

HUDSON: Yeah, Goldman Sachs.

HEDGES: Is perfect.

HUDSON: Yes. The head of Goldman Sachs came out and said, Goldman Sachs workers are the most productive in the world. That’s why they’re paid what they are. And the concept of productivity in America is the income divided by the labor. So if you’re Goldman Sachs and you pay yourself $20 million a year in salary and bonuses, you’re considered to have added $20 million to GDP, and that’s enormously productive. So we’re talking with tautology. We’re talking with circular reasoning here.

So the issue is whether Goldman Sachs, Wall Street, predatory pharmaceutical firms, actually add a product or whether they’re just exploiting other people. And that’s why I called my book Parasitism, because the parasite, people think of the parasite as simply taking money, taking blood out of the host, or taking money out of the economy. But in nature, it’s much more complicated. The parasite can’t simply come in and take something. First of all, it needs to numb. It has an enzyme that numbs the host so the host doesn’t even realize the parasite’s there. And then the parasites have another enzyme that makes the host–it takes over the host’s brain. And it makes the host imagine that the parasite is part of the body, that actually part of itself, to be protected.

Well, that’s basically what Wall Street has done. It’s made, it depicts itself as part of the economy. Not as a wrapping around it. Not as external to it. But actually is the part that’s helping the body grow, and that actually is responsible for most of the growth, when in fact it’s the parasite that is taking over the growth.
So the result is an inversion of classical economics. It turns Adam Smith upside down. It says what the classical economists said was unproductive, parasitism, actually is the real economy, and the parasites are labor and industry, that get in the way of what the parasite wants, which is to reproduce itself, not help the host, the labor and capital [inaud.].

HEDGES: And then the classical economists like Adam Smith were quite clear that unless that rentier income, you know, the money made by things like hedge funds, was heavily taxed, and put back into the economy, the economy would ultimately go into a kind of tailspin. And I think the example of that, which you point out in your book, is what’s happened in terms of large corporations with stock dividends and buybacks. And maybe you can explain that.

HUDSON: There’s an idea in sort of superficial textbooks and the public media that if companies make a large profit, that somehow they make it by being productive. And with–.

HEDGES: Which is still in textbooks, isn’t it?

HUDSON: Yes. And also that if a stock price goes up, you’re just capitalizing the profits. And the stock price reflects the productive role of the company. But that’s not what’s been happening in the last ten years. Just in the last two years, 92 percent of corporate profits in America have been spent either on buying back their own stock, or in paying out as dividends to raise the price of the stock.

HEDGES: And explain why they do this.

HUDSON: About 15 years ago at Harvard, a professor called [Jemson] said, the way to ensure that corporations that are run most efficiently is to make the managers increase the price of the stock. So if you give the managers stock options, and you pay them not according to, you know, how much they’re producing or making the company bigger, or expanding production, but the price of the stock, then you’ll have the corporation run efficiently, financial style.

So the corporate managers find there are two ways that they can increase the price of the stock. The first thing is to cut back long-term investment, and use the money instead to buy their own stock. Just–and when you buy your own stock, that means you’re not putting the money into capital formation. You’re not building new factories. You’re not hiring more labor. You can actually increase the stock price by firing labor.

HEDGES: [Inaud.] temporarily.

HUDSON: Temporarily. By using the income from the past just to buy the stock, fire the labor force if you can, work it more intensively. Pay it out as dividends. And that basically is the corporate raiders model. You use the money to pay off the junk bond holders at high interest. And of course, this gets the company in such trouble after a while, because there is no new investment, markets shrink, that you then go to the labor unions and say, gee, this company’s really near bankruptcy, and we don’t really want to have to fire you.

And the way that you can keep your job is if we just downgrade your pensions, and instead of giving you what we promised, the defined benefit pension, it’s a defined contribution. You know what you pay every month, but you don’t know what’s going to come out at all. So you wipe out the pension funds, push it on to the government, the pension benefit guarantee corporation, and all of a sudden you use the money you were going to pay for pensions to pay stock dividends. And then push it up, and then the whole thing turns down. And it’s hollowed out. And you shrink and you collapse. But by that time, the managers will all have left the company. They will have taken their bonuses and salaries and run.

HEDGES: I want to read this quote from your book, written by David Harvey, in A Brief History of Neoliberalism, and have you comment on it.

“The main substantive achievement of neoliberalism has been to redistribute rather than to generate wealth and income. Accumulation by dispossession. I mean the commodification and privatization of land, and the forceful expulsion of peasant populations, conversion of various forms of property rights, common collective state, et cetera, into exclusive, private property rights. Suppression of rights to the commons. Colonial, neocolonial, and the imperial processes of appropriation of assets, including natural resources. And usury. The national debt, and most devastating at all, the use of the credit system as a radical means of accumulation by dispossession. To this list of mechanisms, we may now add a raft of techniques such as the extraction of rents from patents, and intellectual property rights, and the diminuition or erasure of various forms of common property rights, such as state pensions, paid vacations, and access to education, healthcare, one through a generation or more of class struggle. The proposal to privatize all state pension rights, pioneered in Chile under the [dictatorship] is, for example, one of the cherished objectives of the Republicans in the US.”

This explains the kid of denouement, or the final end result where, which you speak about in your book, is in essence allowing what you call the rentier or the speculative class to cannibalize the entire society until it collapses.

HUDSON: Well, a property right is not a factor in production. Look at what happened in Chicago, the city where I grew up. Chicago didn’t want to have to raise the taxes on real estate, especially on all of the expensive commercial real estate there. So the budget ran up a deficit. They needed money to pay the bond holders. And so they sold off the parking rights to have meters, you know, along the curbs, for the Chicago streets. Well, the result is that they sold to Goldman Sachs 75 years of the right to put up parking meters. So now, the cost of living and doing business in Chicago was raised by having to pay off the parking meters. If Chicago is going to have a parade or something, and block off the traffic, Chicago has to pay Goldman Sachs what it would have made if there wouldn’t have been closed off for a parade. And all of a sudden it’s much more expensive to live in Chicago because of this.

But this added expense of having to pay parking rights to Goldman Sachs to pay out interest to its bond holders is countering this increase in GDP, because you’ve now created more product by charging more. If you sell off a road, a government or local road, and you put up a toll booth and make it into a toll road, all of a sudden GDP goes up. If you go to war abroad, and you spend more money on the military, the military-industrial complex, all this is countered as increased production. None of this is really part of the production system of the capital and labor building more and more factories, and producing more things that people need to live, and to do business. All of this is overhead. But there’s no distinction between wealth and overhead.

And failing to draw that distinction means that the host doesn’t realize that there is a parasite there. The host economy, the industrial economy, doesn’t realize what the industrialists realize from the 19th century: that if you want to be an efficient economy and be low-priced, and sell, under-sell competitors, you have to cut your price by having the public sector provide roads freely. Medical care freely. Education freely. If you charge for all of these then you get to the point that the economy is in, U.S. economy, is in today. Where if American workers, who work for factories, were to get all of their consumer goods for nothing. All of their food, transportation, clothing, furniture, everything for nothing, they still couldn’t compete with Asians or other producers, because they have to pay up to 40%, 43% of their income for rent or mortgage interests, 10% or more of their income for student loans, credit card debt, 15% of their paycheck is automatic withholding to pay social security, to cut taxes on the rich or to pay for medical care.

So Americans, you built into the economy all of this overhead. And there’s no distinction between growth and overhead, and it’s all made America so high-priced that we’re priced out of the market, regardless of what trade policy we have.

HEDGES: And we should add that under this predatory form of economics you game the system. So you privatize pension funds, you force them into the stock market, an overinflated stock market. But because of the way companies are, go public, it’s the hedge fund managers who profit. And it’s those citizens whose retirement savings are tied to the stock market who lose. And maybe we can just conclude by talking about how the system is fixed, not only in terms of burdening the citizen with debt peonage, but by then forcing them into the market to fleece them again.

HUDSON: Well, we talk about an innovation economy as if that makes money. Let’s–suppose you have an innovation, and a company goes public. They go to Goldman Sachs and other companies, Wall Street investment banks, to underwrite the stock. They say, we’re going to issue the stock, say, at $40 a share. What’s considered a successful float is immediately Goldman and the others will go to their insiders, and they’ll say, you know, well, you’ll buy this stock, you’ll guarantee it’ll go up. A successful flotation doubles the price in one day, so that at the end of the day the stock’s selling for $80.

HEDGES: They have the option to buy it before anyone else, knowing that by the end of the day it’ll be inflated, and then they sell it off.

HUDSON: That’s exactly right.

HEDGES: And so the pension funds come in and buy it at an inflated price, and then it goes back down.

HUDSON: It may go back down, or it may be that the company just was shortchanged from the very beginning. And here the important thing is that the Wall Street underwriting firm, and the speculators that come in, that it rounds up, get more in a single day than all the years it took to put the company together. The company gets 40%. These people get also $40. Other people get $40.

So basically you have the financial sector ending up with much more of the gains. And the name of the game if you’re on Wall Street isn’t profits. It’s capital gains. And that’s something that wasn’t even a part of classical economics. They didn’t anticipate that the price of assets would go up for any other reason than earning more money and capitalizing on income. And actually, what you have in the last 50 years, really since World War II, has been asset price inflation, that most families have, middle-class families, have gotten the wealth that they’ve got since 1945 not really by saving what they’ve earned by working, but by the price of their house going up. They’ve benefited by the price of the house. And they think that that’s somehow made them rich.

And the reason the price of the house has gone up is that a house is worth whatever a bank is going to lend against it. And if banks made easier and easier credit, lower down payments, then you’re going to have a financial bubble. And so now, you have, indeed, real estate having gone up as high as it can, I don’t think it’ll take more than 40% of somebody’s income to buy it. But now, if you, imagine if you’re joining the labor force. You’re not going to be able to buy a house at today’s prices, putting down a little bit of your money, and then somehow end up getting rich just on the house investment. All of this money you pay the bank is now going to be subtracted from the amount of money that you have to spend on goods and services.

So we’ve turned the post-war economy that made America prosperous and rich, we’ve turned it inside out, and somehow the most people believe that you could get rich by going into debt to borrow something that’s going to rise in price. And you can’t get rich, ultimately, in going into debt. In the end, the creditors always win, and that’s why every society since Sumer and Babylonia have had to either cancel the debts, or you come to a society like Rome that didn’t cancel the debts, and then you have a dark age. Everything collapses.

HEDGES: And that’s the topic of our second discussion, which is where we’re headed. Thank you, Michael.

And thank you for watching Days of Revolt.